Ground Lease to Secure Financing

The next big trend in commercial real estate investing, ground leases are opening up new avenues for investors. Ground leases are typically long-term property leases where the tenant leases land to develop or improve a commercial property. Often, the physical building and the land it sits on are considered to be separate assets for the purposes of investors.

While ground leases offer benefits to both the owner and lessee, the process of negotiating a ground lease and financing improvements on a ground-leased property can be more complex than traditional real estate leases and financing.

To ensure that a ground lease meets the financing criteria for a leasehold lender, it should include several key components. First, the ground lease should be negotiated to last for a lengthy term. A ground lease term should last well beyond the maturity date of the leasehold financing. This allows adequate time for amortization of the loan, or for the loan to be refinanced.

Ground leases should also include provisions that allow for flexible use of the property. Ground lease contracts that outline broad parameters for permitted use of the property give the leaseholder greater commercial options and open up the property to a larger base of potential lessees.

In addition, ground leases should avoid limitations on mortgaging, reassigning, or subletting the lease to another party. Allowing the leasehold interest to be mortgaged without restrictions ensures that the leasehold lender can move to foreclose on a property if necessary and reassign the lease or sublet the property without needing to obtain the owner’s consent.

Ground leases should also include a clause concerning the right to cure defaults. To protect investment collateral and prevent unforeseen cases where the landlord terminates the ground lease, the leasehold lender must have the right to cure a default on the tenant’s behalf. Typically, the leasehold lender’s cure period extends beyond the tenant’s cure period.

To address cases where the existing ground lease is terminated due to bankruptcy, default, or other reasons, the ground lease should include terms that require the property owner to enter into a new ground lease with the leasehold lender under the same terms as the original ground lease.

Ground leases should also include a requirement that the agreement takes priority over other mortgages or liens. If there is a mortgage or deed of trust placed on the owner’s interest in the property, the ground lease contract should stipulate that these actions are subordinate to the ground lease. This provision preserves the terms of a ground lease in cases where there is a foreclosure sale.

Of course, every ground lease agreement should also include the provision that there will be no changes to the agreement without the leasehold lender’s consent. This includes any attempts by the owner or tenant to amend, modify, terminate, or alter the ground lease. If the parties wish to alter the terms, they must first obtain the leasehold lender’s consent.

Interested investors should seek the advice of experienced legal counsel when negotiating financeable ground leases to ensure the terms are amenable to all parties in the ground lease transaction.