A typical lease agreement involves a landlord (lessor) that allows a tenant (lessee) to use real property owned by the landlord, in exchange for the payment of rent. The landlord owns the real property and all of the improvements, while the tenant owns any personal property they bring with them. This works for short-term periods, during which the landlord does not plan to make any major improvements to the property.
Another type of lease, known as a “ground lease,” allows landlords and tenants to enter into long-term agreements involving the development of real property. California real estate investors can be involved in ground leases as landlords, such as if they want to extract value from a large parcel of land; or as tenants, such as if they want to develop a property for commercial purposes.
What Is a “Ground Lease?”
A ground lease is a long-term agreement between a landlord and a tenant in which the tenant is allowed to develop the leased property. At the end of the lease term, the landlord retains ownership of the improvements made by the tenant.
In terms of risk, the tenant takes on a considerable amount of responsibility in a ground lease.The landlord gives up use of the land for a long period of time and also risks the loss of the property if the tenant uses it as collateral for a loan.
Ground Lease Term
Since a ground lease involves a development project, the lease term tends to be much longer than other leases. An ordinary commercial or residential lease might last one year, with possible extensions. The duration of a ground lease might be 50 years or longer.
Rent and Other Consideration
Rent payable under a ground lease might be a percentage of the property’s appraised value, the tenant’s revenue from the development on the property, or some combination. The more the property value increases, or the more money the tenant makes, the more rent the landlord receives. The tenant is typically also responsible for payment of property taxes during the lease term.
Ownership of Improvements
Improvements to real property, such as buildings and infrastructure, become part of the real property. Since the landlord owns the real property, the landlord owns the improvements made by the tenant.
Use of the Land as Security for Construction Loans
Unless a tenant has enough cash on hand to pay for their entire development project, they will need to secure financing. This might require the use of the real property as collateral for a loan, with the landlord’s agreement. A “subordinated” ground lease is one in which the landlord has agreed to give a lender a superior security interest in the property. In an “unsubordinated” ground lease, the landlord does not agree to a lower-priority claim.
Examples of Ground Leases
An ideal scenario for a ground lease might involve a landlord who owns a tract of unimproved land and a tenant who wants to pursue a development project. The federal government and many state and local governments, as major landowners in California and other western states, offer numerous examples of ground lease arrangements. In the Las Vegas, Nevada area, for example, the state and county governments make land available for ground lease, and they have also sold both land and the attached ground leases to private investors. Ground leases on government-owned land can have their disadvantages as well, as multiple businesses in Palm Springs, California have recently learned.
More Blog Posts:
California Real Estate Agents’ and Sellers’ Duty of Disclosure to Prospective Buyers, Titles and Deeds, September 18, 2017
Real Estate Financing for California Real Estate Investors, Titles and Deeds, August 17, 2017
What California Real Estate Investors Should Know About Commercial Leases, Titles and Deeds, August 10, 2017