how a ground lease works
a ground lease indicates that improvements will be owned by the property owner unless an exception is created and stipulates that all relevant taxes incurred during the lease period will be paid by the tenant because a ground lease allows the landlord to assume all improvements once the lease term expires the landlord may sell the property at a higher rate ground leases are also often called land leases as landlords lease out the land only although they are used primarily in commercial space ground leases differ greatly from other types of commercial leases like those found in shopping complexes and office buildings these other leases typically don t assign the lessee to take on responsibility for the unit instead these tenants are charged rent in order to operate their businesses a ground lease involves leasing land for a long term period typically for 50 to 99 years to a tenant who constructs a building on the property 1tenants generally assume responsibility for all financial aspects of a ground lease including rent taxes construction insurance and financing a 99 year lease is generally the longest possible lease term for a piece of real estate property it used to be the longest possible under common law however 99 year leases continue to be common but are no longer the longest possible under the law the ground lease defines who owns the land and who owns the building and improvements on the property many landlords use ground leases as a way to retain ownership of their property for planning reasons to avoid any capital gains and to generate income and revenue tenants generally assume responsibility for any and all expenses this includes construction repairs renovations improvements taxes insurance and any financing costs associated with the property example of a ground leaseground leases are often used by franchises and big box stores as well as other commercial entities the corporate headquarters will normally purchase the land and allow the tenant developer to construct and use the facility there s a good chance that a mcdonald s starbucks or dunkin donuts near you are bound by a ground lease many of macy s stores are ground leased macy s owns the buildings but still pays rent on the ground the building is on as of jan 28 2023 macy s reported long term lease liabilities of 3 billion this leased real estate includes small format stores distribution centers office space and full line stores 23some of the fundamentals of any ground lease should include subordinated vs unsubordinated ground leasesground lease tenants often finance improvements by taking on debt in a subordinated ground lease the landlord agrees to a lower priority of claims on the property in case the tenant defaults on the loan for improvements in other words a subordinated ground lease landlord essentially allows for the property deed to act as collateral in the case of tenant default on any improvement related loan for this type of ground lease the landlord may negotiate higher rent payments in return for the risk taken on in case of tenant default this may also benefit the landlord because constructing a building on their land increases the value of their property in contrast an unsubordinated ground lease lets the landlord retain the top priority of claims on the property in case the tenant defaults on the loan for improvements because the lender may not take ownership of the land if the loan goes unpaid loan professionals may be hesitant to extend a mortgage for improvements although the landlord retains ownership of the property they typically have to charge the tenant a lower amount of rent advantages and disadvantages of a ground leasea ground lease can benefit both the tenant and the landlord the ground lease lets a tenant build on property in a prime location they could not themselves purchase for this reason large chain stores such as whole foods and starbucks often utilize ground leases in their corporate expansion plans a ground lease also does not require the tenant to have a down payment for securing the land as purchasing the property would require therefore less equity is involved in acquiring a ground lease which frees up cash for other purposes and improves the yield on utilizing the land 1any rent paid on a ground lease may be deductible for state and federal income taxes meaning a reduction in the tenant s overall tax burden the landowner gains a steady stream of income from the tenant while retaining ownership of the property a ground lease typically contains an escalation clause that guarantees increases in rent and eviction rights that provide protection in case of default on rent or other expenses there are also tax savings for a landlord who uses ground leases if they sell a property to a tenant outright they will realize a gain on the sale by executing this type of lease they avoid having to report any gains but there may be some tax implications on the rent they receive depending on the provisions put into the ground lease a landlord may also be able to retain some control over the property including its use and how it is developed this means the landlord can approve or deny any changes to the land because landlords may require approval before any changes are made the tenant may encounter roadblocks in the use or development of the property as a result there may be more restrictions and less flexibility for the tenant costs associated with the ground lease process may be higher than if the tenant were to purchase a property outright rents taxes improvements permitting as well as any wait times for landlord approval can all be costly landlords who don t put in the proper provisions and clauses in their leases stand to lose control of tenants whose properties undergo development this is why it s always important for both parties to have their leases reviewed before signing depending on where the property is located using a ground lease may have higher tax implications for a landlord although they may not realize a gain from a sale rent is considered income so rent is taxed at the ordinary rate which may increase the tax burden 