What is a Ground Lease? (Benefits, Drawbacks & More)

Choosing a real estate investment strategy can be difficult. There are risks no matter which path you choose, but it’s important to understand all your options, including leasing the land.

Ground leases can be a good option for landlords and property owners who want prime real estate, but they can be harmful if you don’t understand what a ground lease is and how it works.

We’ve detailed everything you need to know about land leases and what landlords and tenants should consider.

What is a land lease?

Land leases are different from other types of leases. In a land lease, the tenant owns the building but not the land. The land is undeveloped and if a tenant leases it, they have the right to develop it during the lease term.

The term of a land lease is usually very long, in some cases up to 99 years. This is because at the end of the lease, the land and any improvements (including the building) are returned to the owner. The tenant pays periodic rent to the landlord, similar to when renting a building.

Land lease terms and rights

Tenants should pay close attention to the terms of their land lease as well as the terms of purchasing land or real estate.

This period is essential because it should last at least as long as necessary to recoup the cost of construction and improvements to the building.

However, the terminology in the title is just as important. A title agreement is essential even if the tenant does not purchase the land. At a minimum, you should have title insurance to protect your leasehold interest in the land.

When entering into a land lease agreement, tenants should consider the following regarding the promise of ownership:

• You must receive all appendices for the title.
• To avoid legal issues, the title name recipient must match the landlord’s name exactly.
• Ensure title premiums are paid and leasehold title policies are fulfilled.
• Determine whether you need to subordinate your existing loan to a land lease.

Advantages and disadvantages of land lease

Land leases offer benefits to both the lessee and the lessor.

Benefits for lessees

• Built in a prime location: Tenants do not have to worry about purchasing land, so they have a better chance of building in prime locations. Leasing land is much more affordable than buying land and allows for more options.
• Reduced out-of-pocket costs: Because tenants don’t need money to put on land, they may have access to more land and more money for construction and improvements.
• Reduced tax burden: Land rental fees are tax deductible for business owners and may reduce their tax liability.

Disadvantages for renters

• Possible limitations: Tenants who do not own the land may need to seek permission or obtain approval to make improvements or changes. This can be a burden and can limit what you can do.
• Improvements are lost: If the tenant does not extend the lease at expiration, any improvements made to the land will be transferred to the owner.
• Taxes and insurance fees are the responsibility of the tenant. All taxes, insurance and maintenance costs are the responsibility of the tenant.

lessor’s profit

• Stay in control: Depending on how the landlord writes the lease, he or she may be able to control improvements to the property to avoid unnecessary problems or unwanted improvements.
• Regular income: Landlords can benefit from the stable income of a land lease without the hassle of carrying out renovations themselves. Landlords can also include escalation clauses so that the rent increases in line with market rents.
• Retain ownership of improvements. Once the lease expires, the landlord takes ownership of all land improvements unless the tenant extends the lease.

Disadvantages of lenders

• Lease agreements require strict wording. Without the right attorney, a landlord can easily be taken advantage of if they have no control over improvements to the property.
• Rent is taxable income: Income derived from ground rent can significantly increase a landlord’s tax burden.

Land lease negotiation considerations

When negotiating a land lease, tenants should consider the following:

• If the homeowner wants to sell, request a right of first refusal to give them options.
• Clearly outline how the improvements will be handled at the end of the lease, including whether the tenant is responsible for destroying the improvements.
• Determines how market rents are determined based on the current use of the property, or based on the highest and best use (current use being more preferred).

The role of land leases in investment strategies

Investors who want to diversify their portfolio can invest in ground leases. When a tenant builds on the land, the value of the property increases and they earn even more profit when they sell the land or acquire improvements at the end of the lease.

Of course, like any investment, there are no guarantees. Landlords should always have escalation clauses in place to charge higher rents as the market dictates, and there is always a risk that an unscrupulous tenant will default on the lease.

final thoughts

Ground leases are a good way to diversify your portfolio or secure land for real estate without raising capital. It is essential that you understand the nuances of lease agreements and have the assistance of an attorney to ensure that you are properly protected.

Note by BiggerPockets: These are the opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.