A Ground Lease Overview – Examining the Pros and Cons

Ground leases are long-term rental agreements in which a tenant rents land from a landlord, builds a property on it, and then returns both the land and the improvements made to the landlord at the end of the lease term. The agreement requires the tenant to pay the applicable taxes while the lease is in effect. The lessor may sell the property on the land for any price once the lease term expires unless the agreement states otherwise.

Subordinated and unsubordinated are the two forms of ground leases. In a subordinated ground lease, the landlord’s claim to the property is secondary in the event of a tenant loan default, making it possible for them to lose the property. Meanwhile, in an unsubordinated ground lease, the lessor has the highest priority claim, allowing them to retain the property if the tenant defaults.

Ground leases differ from standard real estate leases in several ways. They involve the lessee renting raw or partially improved land (whose present condition the owner does not intend to preserve) and developing the property, whereas standard leases involve renting an already developed property. Ground leases also tend to have long-term periods, such as 25 to 99 years, and put the tenant in a similar position to a property owner.

Tenants and landlords can both significantly benefit from entering a ground lease agreement. For lessees, ground leases allow them to construct property in prime locations without the burden of making a substantial investment in land, freeing up capital for other investments. They also provide long-term security, with terms extending to many decades. Additionally, ground leases offer a tax advantage, as the rents a tenant pays under the lease are tax-deductible, reducing their overall tax liability.

On the other hand, landlords can benefit from ground leases by receiving a constant income stream while retaining property ownership. The lease often includes provisions for rent increases and eviction rights, protecting the landlord against potential default. Ground leases also provide tax advantages, as landlords avoid reporting capital gains from selling the property outright, though there may still be tax implications on the rent received.

However, ground leases may also come with some drawbacks. For tenants, these may include reduced flexibility (as landlords may require approval before allowing them to make changes to the property) and higher costs (including rent, taxes, permits, and improvements) compared to if the tenant had purchased the property outright.

Similarly, landlords may experience potential drawbacks of ground leases, such as the risk of losing control of the property if they do not include necessary clauses in the lease. Ground leases may also have significant tax consequences because rent is classified as income and is taxed at the regular rate. To avoid these issues, landlords must thoroughly review their lease before signing.

Bifurcation, the separation of land ownership from the ownership of physical buildings, is a key aspect of ground leases. This clear ownership structure creates a predictable and stable environment for all parties involved in real estate transactions, and provides landlords with greater versatility and increased rental income. According to Jay Sugarman, CEO and chairman of Safehold, a real estate investment firm specializing in ground leases, bifurcation enables real estate owners to utilize their expertise in building management without tying up valuable capital in land ownership.

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