A ground lease is a long term lease of land, usually 50 to 99 years, where the tenant pays rent for the land and builds, owns and operates a building on it. When the lease ends, the land and usually the building go back to the landowner.
That is the short answer to what is a ground lease. It splits the land from the building: one party keeps the dirt, the other owns what sits on it. In commercial real estate, ground leases are common under franchises, big box stores, hotels and office buildings where the landowner will not sell. Below is how a ground lease works, who pays for what, the pros and cons on each side and what to negotiate.
How Does a Ground Lease Work?
Ground leases work by separating ownership of the land from ownership of the improvements. The landowner leases out the site, and the tenant pays ground rent, handles development and construction and runs the property for the length of the lease.
There are 3 things that set a ground lease apart from a normal commercial lease:
- Long term – Ground leases typically run 30 to 99 years, with 50 years a common midpoint. The tenant needs enough time to recover what it spends on the building.
- The tenant owns the improvements – In a standard lease, the landlord owns the building. In a ground lease, the tenant builds and owns it for the lease term.
- A net structure – Ground leases are almost always net leases. The tenant pays property taxes, insurance and all maintenance. See what a triple net lease is.
Ground rent is usually set at signing, with scheduled increases or periodic adjustments, so ground leases keep pace over time.
Who Owns the Land and Who Owns the Building?
The landowner owns the land for the whole term, and the tenant owns the building and improvements until the lease ends. At the end, the improvements usually pass to the landowner at no cost, unless the lease says otherwise.
This is why the end of the term matters so much. As ground leases get close to expiring, the structure is worth less to the tenant, who will soon lose it. Many tenants negotiate renewal options or a purchase right well before that point. Some landowners agree to extend because it benefits both sides.
Ground Lease vs Buying Land vs a Build-to-Suit
Ground leases sit between buying a site and leasing a finished building. The difference is who pays for the land, who pays for the building and who ends up owning each.
| Option | Who owns the land | Who builds | Who owns the building | Typical length |
|---|---|---|---|---|
| Buy land and build | You | You | You | As long as you own it |
| Ground lease | Landowner | Tenant | Tenant, until the lease ends | 30 to 99 years |
| Build-to-suit lease | Developer or landlord | Developer | Developer or landlord | 10 to 20 years |
| Sale-leaseback | Buyer | Already built | Buyer | 10 years or more |
If you want a new facility but do not want to fund it, a build-to-suit may fit better. If you want to own what you build and keep your capital out of the dirt, ground leases may be the answer.
Subordinated vs Unsubordinated Ground Leases
The biggest issue in most ground leases is financing, and it comes down to whether the land is on the line for the tenant’s loan. A leasehold mortgage is a loan against the leasehold, which is the tenant’s right to use the site and its ownership of the improvements.
- Unsubordinated ground lease – The landowner keeps the land free of the tenant’s loan. On a default, the lender can take over the leasehold, but not the land. This protects the landowner, and it can make the tenant’s financing harder and more expensive.
- Subordinated ground lease – The landowner lets the land stand behind the tenant’s loan. On a default, the landowner can lose the land. Financing is easier, so the landowner usually asks for higher ground rent in return.
Lenders also want a lease term that runs well past the end of the leasehold mortgage, plus the right to step in and cure a default. If you plan to borrow, talk with your lender first.
Pros and Cons of a Ground Lease
A ground lease lets a tenant build without buying the land, and lets a landowner earn income without selling. The cost is complexity on both sides, and a clock that eventually runs out.
For the tenant
- Less capital up front, with no site to buy.
- Access to sites that are not for sale.
- You own and control the improvements for the term.
- You develop a site you will never own, and the improvements usually go back at the end.
- Financing can be harder, and rent rises over a very long time.
For the landowner
- Long term income without selling.
- You keep ownership, and the improvements usually come to you at the end.
- The tenant pays taxes, insurance and maintenance.
- You give up use of the site for decades, and it can be hard to change course.
- You rely on the tenant to operate and look after the property.
The tax effects on both sides depend on your situation, so talk with your tax advisor and attorney.
What to Negotiate in a Ground Lease
Most of the value in a ground lease is decided by a few clauses. Negotiate these before you sign, whichever side you are on.
- Term and renewals – Enough years to recover the cost of the building and satisfy a lender.
- Rent increases – Fixed steps, or periodic adjustments, and how they are calculated.
- Use – What can be built and operated on the land, and how that can change.
- Ownership at the end – Who owns the improvements, and whether the tenant must remove them.
- Financing rights – Whether the tenant can pledge the leasehold, and what protections a lender gets.
- Transfer rights – Whether the tenant can sell or assign, and whether the landowner can sell the land.
- Purchase rights – A right of first refusal or an option to buy the land.
- Default – How much time each side has to cure a problem.
Ground leases can outlast everyone who signs them, so have an attorney who knows them review it.
When a Ground Lease Makes Sense
Ground leases make sense when a great site is not for sale, or when a tenant would rather put its capital into the development and the business. For a landowner, it makes sense when you want income from the land and have no reason to sell.
They are usually the wrong fit when you need flexibility, when you may want to redevelop within a few decades, or when lenders in your market will not finance the structure.
Inventure Capital develops, acquires, builds and operates commercial real estate across Minnesota and the Upper Midwest. If you own land or a building and want to talk through your options, bring us an opportunity or schedule a call. If you are a business that needs a new building, our sister company Inventure Real Estate covers build-to-suit vs buying vs leasing.
Frequently Asked Questions
The landowner keeps ownership of the land for the entire term. The tenant has the right to use it and owns the building it puts there until the lease ends.
The land and usually the building go back to the landowner, unless the lease says otherwise. Many tenants negotiate renewal options or a right to buy the land well before the term runs out.
Yes, in most cases. Ground leases are usually net leases, so the tenant pays property taxes on the land and the building, along with insurance and maintenance.
The tenant does not own the land, the structure usually goes back at the end, and financing can be harder. For the landowner, the site is tied up for decades and depends on the tenant’s performance.
They usually mean the same thing. Both lease the land only. “Ground lease” is the common term in commercial real estate, while “land lease” is also used for things like farming and solar projects.
This article is general information only. It is not tax, legal or investment advice, and it is not an offer to buy any property or to sell any security.