Ground Leases are far more complex than fee simple NNN property leases and typically involve a greater number of contracting parties than is usual. A Ground Lease tenant attains rights to build and use improvements on the leased land (ground) during a specified period of time. Ground lease properties can be NNN Triple Net or another variant. The lessee enjoys the ownership and use of any property improvements (buildings, usually), and pays rent to the landlord for use of the land, until the end of the lease term (leasehold financing). After the lease has run its course, the entire NNN property, along with any tenant-constructed, improvements, revert to the landlord – unless there is an exception in the lease.
A Ground lease term can range between 30 years to 99 years. A prominent example is the Empire State Building, built in 1931, in New York City, NY, has a ground lease that runs until 2076. Ground lease buildings in NYC typically have a 99 year lease agreement with two 20 year extension options (leasehold financing). A good real estate broker or attorney can inform you of a ground lease during legal and financial due diligence. However, an investor can also study a building’s financial statements, if available. If the building has title to the land it sits on, an investor will see land as one of its assets in its balance sheet. On the flip side, the investor will see lease payments as an expense in the building’s income statement if it sits on a ground lease.
Both tenant and landlord use this commercial real estate contract to negotiate on: term, improvements, land development rights, rents and setoffs, property use, leasehold financing, default, damage, destruction, transfer rights, naming rights, etc. Both parties can benefit, see below:
- Tax benefits accrue to the tenant. Rent is deducted as business operating expenses by the tenant, and the improvements constructed also be depreciated and provide another tax shelter to the tenant;
- While investing in a Ground Lease NNN property, the tenant gets permission to build customized improvements;
- The tenant is able to own a desirable property without capital outlay;
- The improvements built by the tenant on the leased ground help the landlord enhance the value of the property and adjacent, owned properties;
- The landlord retains ownership of the property absent the financial burden and risk of land development. Instead, the landlord gets a predictable, rent income from the lease (ground rent payments);
- If the landlord is a local government, ground leasing lands may spur the development of other municipal lands in the vicinity;
- The landlord can avoid potential capital gains due to appreciation in the value of the land, should a sale have occurred instead of a Ground lease.
There are 2 broad types of Ground Lease NNN properties:
Subordinated: here the landlord is in first position of lien, not the lender. The landlord also holds all the other claims on the land in case of tenant default on any debt used to finance improvements. Subordinate leases are not the norm.
Un-subordinated: This type of NNN Ground lease investment is the most common in commercial real estate. Should a tenant default on debt, then the lender has claim on building and improvements, but not the land. As the lender has no claim on the land, the landlord’s risk is lower than otherwise. However, the lender is placed in the curious position of being the defacto tenant and must make ground rent payments until and unless, the landlord is able to find a replacement tenant.
Call your trusted commercial real estate specialists at the Triple Net Investment Group today, and discuss your Ground lease to see how you might do better.
