What Is a Ground Lease?

What Is a Ground Lease?

Let me explain what a ground lease is. It's an agreement where you, as the tenant, get to develop a piece of property during the lease period, and then at the end, the land and everything you've built on it goes back to the property owner.

Key Takeaways

You should know that a ground lease lets you develop property during the lease, after which it reverts to the owner. These are common in commercial settings, where landlords lease land for 50 to 99 years to tenants who build on it. If you can't afford to buy land outright, this allows you to construct what you need, while the landlord gets reliable income and keeps control over the property's use and development.

How a Ground Lease Works

In a ground lease, the agreement states that improvements belong to the property owner unless specified otherwise, and you as the tenant pay all relevant taxes during the lease. This setup lets the landlord sell the property at a higher price later because they take over all improvements when the lease ends. These are often called land leases since only the land is leased out.

Ground leases stand apart from other commercial leases, like those in malls or offices, where tenants just pay rent to operate without building responsibilities. Here, you're leasing land long-term, usually 50 to 99 years, to construct a building. You generally handle all financial aspects, including rent, taxes, construction, insurance, and financing.

A 99-year lease is typically the maximum for real estate, rooted in common law, though it varies by jurisdiction—most U.S. states cap it at 99 years. The lease clearly defines ownership: the landlord owns the land, while you own the building and improvements during the term. Landlords use these to keep property ownership for planning, avoid capital gains, and generate revenue, with you covering all expenses like construction, repairs, taxes, insurance, and financing.

Example of a Ground Lease

You'll see ground leases used by franchises and big box stores. Often, the corporate entity buys the land and lets a tenant or developer build and use the facility. Think of your local McDonald's, Starbucks, or Dunkin Donuts—they're likely under a ground lease.

Macy's is another example; they own the buildings but pay rent on the ground. As of February 3, 2024, Macy's reported long-term lease liabilities of nearly $3 billion, covering small stores, distribution centers, offices, and full-line stores.

Subordinated vs. Unsubordinated Ground Leases

If you're a tenant financing improvements with debt, the type of ground lease matters. In a subordinated one, the landlord takes a lower priority on claims if you default on the loan, using the property deed as collateral. This risk might mean higher rent for the landlord, but it boosts property value with new buildings.

An unsubordinated ground lease keeps the landlord's top priority on claims if you default, which might make lenders wary of issuing mortgages since they can't claim the land. This often leads to lower rent charges from the landlord, who retains ownership.

Advantages and Disadvantages of a Ground Lease

Ground leases can work well for both sides. As a tenant, you get to build in a prime spot you couldn't buy, without a down payment, freeing up cash and possibly deducting rent on taxes. Landlords enjoy steady income, escalation clauses for rent increases, eviction protections, tax savings by avoiding sales gains, and some control over property use.

On the downside, as a tenant, you might face restrictions needing landlord approval, higher overall costs than buying, and roadblocks in development. For landlords, poor lease provisions could mean losing control, and rent income might increase tax burdens without offsets like depreciation.

Common Questions About Ground Leases

You might wonder about disadvantages: they include potential property loss at expiration, missed income from market changes without rent escalations, and tax issues where expenses can't offset income. Is it a good investment? It can be, letting you build without buying land, though restrictions apply. When it expires, you leave, and everything reverts to the landlord, but extensions are possible; otherwise, it continues on the same terms until ended.

The Bottom Line

To wrap this up, a ground lease lets you develop property during the term, then it all goes back to the owner. These are standard for commercial landlords leasing land for 50 to 99 years to builders. If buying land is out of reach, you can still use it, while the landlord gets income and control.