Ground Lease Definition
A ground lease is a kind of lease where the lease agreement is written in such a way that the tenant of the property will be authorized to do all the necessary developments during the lease period. Then the property will be handed over to the property owner, including the developments and changes the tenant has made during the period of the lease.
A ground lease is generally associated with the freehold properties, say a piece of land. In this leaseLeaseLeasing is an arrangement in which the asset's right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.”, the tenant who uses the property can make changes and improvements for their benefit, which, after the completion of the lease period, will be handed over to the landlord with all the improvements and changes made.
It is a source of income for the landlords since they are getting improved and renovated piece of land, which they have provided earlier to the tenants. It is also known as economic rentEconomic RentEconomic rent is the amount paid to the owner of a factor of production in excess of the cost that must be incurred in order to use such factors in the production process. It is the amount paid for goods that were not produced.. It has been witnessed that this type of ground lease agreement is generally made when the lease period for a long time, for example, 50-60 years or more.
Types of Ground Lease
There are two types of Ground Lease one is Subordinated and unsubordinated.
- Subordinated Ground Lease – It is a type of lease where the owner gets all the benefits derived from the repair and maintenance done by the tenants. The owner of the land will have a less claiming power in this type of lease.
- Unsubordinated Ground Lease – It is a type of lease where the landowner will enjoy maximum claiming power. The claiming power is regarding the loan which the tenants usually take to make all the improvements in the property during their stay on the lease period agreed. The owner can easily claim for the refund in case the tenants are found, defaulter.
Example of Ground Lease
Many big corporates purchase the piece of land in any big cities and then push that on lease to the tenant. The tenants, in this case, who are also big brands come to the owners and finalize one agreement. The ground lease agreement is done for big property and big businesses.
Mike has received a piece of land on his marriage from his parents, and it was an agricultural land which is located in some isolated place. Mike is working somewhere in the city and therefore it was challenging for him to look after the agricultural land. He has decided to put the land on lease for some 10 years and will sit back and enjoy the returns also he will avail the tax benefitsAvail The Tax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place. from the leased land at the year-end.
- The ground lease is a good source of return on investment when it comes to the owner of the property. The land which the owner gives on a lease will always be appreciated also if it is located in a prime area, then the premium appreciation will be there. The owner of the land will be much benefited with this type of lease agreement.
- It helps the tenants from the market fluctuation since the lease paymentsLease PaymentsLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration., and the terms are predefined. The tenants will not have to rethink according to the market condition. The lease is somewhat fixed, and it gets raised according to the agreement, irrespective of the market condition.
- The most significant advantage is that it has a huge tax advantageTax AdvantageTax Advantage are the types of investments or saving plans that benefit tax exemption, deferred tax, and other tax benefits. Examples include Government bonds, Annuities, Retirement Plans. for both the owner and the tenants. The tenants don’t have to pay taxes on the lease; also, they get the deduction for the rent they are paying. On the other hand, the landowner will not have to pay any property tax in some cases if the property is under Municipal Corporation or very less property tax if it is private.
- It is also beneficial for the financial aspect; also, the tenants can invest in a piece of land to develop for their business and don’t have to invest money to buy the property, which is very costly.
- In case of a ground lease, the tenants are not required to make any down paymentsDown PaymentsDown payment is the initial deposit made by the buyer to the seller when purchasing an expensive item, such as residential property or a car. It comprises a portion of the total purchase amount of the asset and takes place via cash, bank check, credit card, or online banking. for confirming the deal the way we used to do in case of purchasing any property. Therefore it has been seen that less equity is involved in the case of a ground lease.
- The most significant and most prominent disadvantage of the ground lease is that the owner of the property may have less control in regard to the improvements and developments which tenants make.
- Sometimes it is also seen that the tenants are required to seek some approvals if they require making any improvements or changes, and therefore, at times, it becomes a roadblock for the tenants to think of the improvements and necessary changes.
- There can be tax complications because the cost of the land and the indexationIndexationIndexation is a method of adjusting the purchase price of an investment (bonds, debentures, or any other asset class) to account for the effect of inflation over the investment term, lowering the capital gain and reducing taxable income. may vary at the time of computing tax implication.
The ground lease is a typical type of lease in which the piece of land is kept on lease to the tenants, and tenants are required to make all the necessary changes they want to incorporate during their lease term. At the end of the lease period, the entire property is handed over to the owners, along with all the improvements and developments.
In some aspects, it is beneficial for the tenant and the owner, and in some respect, it is not. The parties who are willing to get themselves indulged in this type of agreement must carefully read and understand all the lease terms and its effects in the future.
This article has been a guide to Ground Lease and its definition. Here we discuss how does ground lease work with its types, for example, advantages and disadvantages. You can more about finance from the following articles –