How Ground Leases 2 0 Create Value And Avoid Disaster

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Ground leases involve leasing land for a long-term period to a tenant who then constructs a structure on that property. For example, since they are building on land they don’t own, tenants may need to get the approval of the landlord before construction can begin. And tenants can lose control of their building after the term of the lease expires. Specifically, American Tower has ground leases on roughly two-thirds of its U.S. towers, and it has over 35,000 separate landlords. It has an average of 28 years remaining on its ground leases, but instead of letting any of its leases expire, the company’s general practice is to either extend the lease or buy the land to terminate the ground lease. As the name implies, a ground lease only involves leasing the ground — not any buildings. A ground lease involves undeveloped commercial land that is leased to tenants, who then have the rights to develop and use the property for the duration of the lease.

Can you depreciate leased property?

If you are leasing land or renting property, you can depreciate its value over time for tax purposes and to determine the current fair market value. … To claim depreciation on property, the Internal Revenue Service (IRS) requires that the leased property be used in your business or for income-producing activities.

The landowner leases the land to the developer of the improvements, who pays rent for use of the land. While such lease terms do not particularly favor developers, ground leases offer some distinct advantages. On the other hand, an unsubordinated ground lease is a ground lease where the landowner maintains its first position in the hierarchy of claims on the asset. In this case, a lender would not have the right to take back the land in the case of a default by the tenant. This unsuborninated position is considered much safer for the landowner and as such this usually comes with a lower lease rate. Under an unsubordinated ground lease lenders will be more reluctant to lend, but will usually just take into account the lease payments during loan underwriting when determining the maximum loan amount on the property. In an unsubordinated ground lease, the landowner retains top priority on the property in case the tenant defaults on loans taken for undertaking improvements on the land.

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They also give developers the opportunity to involve multiple partners without a formal partnership agreement. NNN ground leases are usually very long-term , but if the tenant ever defaults or the term of the lease expires, then the landowner will take over ownership of the building on their land as well. One case in particular would be when it facilitates debt financing to construct a building that will add value to adjacent properties also owned by the owner of the ground lease. This would provide the landowner with additional benefits outside of the subject transaction. Another reason is that the land owner could in exchange negotiate higher lease payments or otherwise more favorable terms. Ground leases are an important component of many commercial real estate deal structures. Yet for a lot commercial real estate professionals ground leases are rarely encountered and are poorly understood.

Ground Lease

These and other measures can help a modern tenant create a flexible, stable, safe, and valuable leasehold estate that is almost like owning the property. As long as the lease also gives the landlord comfort that the building, the rental stream, and hence the landlord’s position will retain their value, the landlord can live with a modern ground lease too.

Commercial Terms Of The Ground Lease Arrangement

The reduction in cash usually required causes the investment yield to increase when the income stream is extended into the future. As you’re considering investing in a ground lease for sale, it’s important that you understand the benefits and responsibilities you’ll have as the landowner. While a ground lease can be advantageous over a very long-term period for property owners, there are some key details to understand before adding a ground lease to your portfolio. From a landlord’s point of view, there are several common reasons why a ground lease might be desirable, as opposed to developing the property themselves or selling the land parcel outright. For one thing, developing commercial buildings can be a capital-intensive process. Ground leases allow owners of commercial land to monetize their real estate without significant capital requirements. It, however, depends on the viability and success of the project or business undertaken on the property.

A ground lease stipulates that the property owner will own any improvements unless the parties create an exception. This type of contract also stipulates that the tenant will pay relevant taxes during the period of the lease. Landlords may be able to sell the property on the land at a higher rate once the term of the lease expires because they can assume all improvements at that point. Just like most other real estate leases, ground leases require tenants to make regular rent payments. And ground leases are generally net leases, which means that tenants are responsible for paying property taxes, insurance, and maintenance expenses for the duration of the lease. Ranjan Samarakone Landlords under old ground leases rarely want to sell.

What You Should Know About Commercial Real Estate Leases

The lessor may be entitled to receive back the property with all its improvements once the lease period is over. It is in addition to the amount which the lessor is supposed to get as per points 1 or 2 above.

In addition, they have significant lender and tenant relationships and a strong track record for performing on their contractual obligations. Their plan is sign a ground lease and quickly develop a quick service store like Starbucks or McDonalds. They have a letter of intent and the lease amount is sufficient to cover the construction loan and ground lease payments. Given the financial strength of the end tenant and the investor’s experience, this is a relatively low risk situation. In a traditional construction loan, the lender requires a first position lien on the property and all improvements thereto.

For many, this is preferable to sitting on a vacant piece of land while continuing to pay carry costs. Also, if the landowner owns multiple nearby parcels, the development of one can positively impact the value of their surrounding assets. A Ground Lease / Land Lease, is a long term lease whereby a property owner leases their land to an investor. In return for their rent, the investor gets the right to construct a building on the property.

The project is eligible for a Government Property Lease Excise Tax agreement, meaning that all real property taxes during the 25-year agreement can be replaced with a lease excise tax. For Caliber, this provides a tax incentive while simultaneously stimulating development for the City of Tucson. Otherwise unusable land for Caliber, the ground lease offers prime real estate with added benefits. There are two main types of a ground lease agreement – subordinated and unsubordinated ground lease. The main differences between the two are in relation to the tenant’s loan financing on real estate property improvements. Because the lender cannot take ownership of the land in an unsubordinated ground lease should a tenant not pay their loan, prospective lenders may hesitate to extend a mortgage so a tenant can make improvements.

As a result, landlords usually have to charge lower rent to the tenant. A landlord who signs an unsubordinated ground lease retains top priority if there are claims on the property. This means that tenant’s lenders cannot foreclose on the land if the tenant defaults on the loan. If the tenant defaults, the lender could go after the tenant’s business assets . However, the lenders cannot gain full control of the property as they could do with a subordinated ground lease. Ground leases can provide great investment opportunities for people who want to deploy capital in real estate while never having to think about property management. The investor becomes the landlord under a long-term lease, often lasting 99 years.

Advantages Of A Ground Lease

And even though it makes his position safer than it would be in a subordinated lease, the lender becomes hesitant to extend loans to the tenant as they cannot claim the property in case of a default. In a deal that involves a ground lease, one of the challenges that a commercial real estate investor/developer typically faces is getting financing for the construction of their project. This is because a typical construction lender requires a first position lien on the commercial property as collateral for their loan.

Can I deduct deferred rent?

For instance, in the case of a rental agreement calling for a deferral of rental payments, an accrual method lessee could deduct the amount of rent due for a particular year, even though that rent had not been paid, while a cash method lessor would not have to report income until later in the lease term, when the …

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It gets a significant amount of traffic and it is located in a high growth city with strong median income. You are confident the parcel would be perfect for your client, a major drug store. A land lease agreement has premises for escalation and eviction rights, as well. Ground lease has been a staple in commercial real estate investment financing. There are three potential downsides to making an investment in a deal with a ground lease arrangement.

  • There are two key differences between a ground lease and a traditional commercial real estate lease.
  • The two most prevalent types of ground leases are subordinated and unsubordinated.
  • Further, giving up the first claim on the land also allows him to negotiate favorable terms, including a higher rent.
  • I have led multi-disciplinary teams to achieve important business goals and have successfully negotiated many multi-million dollar deals.
  • The selection of the discount rate would largely depend on how risky these future cash flows are.

Rent may increase over the term of the agreement, depending on the viability and success of the business. In this webinar session, Bo Barron will show you how presence, a great value proposition, and a targeted prospecting campaign can grow your business without chaos! Learn from private equity fund managers how to become a top CRE operator and investor. The Law Office of David Watson, LLC provides comprehensive and individualized estate-planning services for all stages and phases of life. I listen to your goals and priorities and offer a range of estate-planning services, including trusts, wills, living wills, durable powers of attorney, and other plans to meet your goals. And for convenience and transparency, many estate-planning services are provided at a flat rate. So, for both parties to the lease, it is critically important to understand what happens when it expires.

Ground Lease

However, it can take a long time to complete construction so a ground lease term is much longer. There are two key differences between a ground lease and a traditional commercial real estate lease.

Ground Lease

For example, if you want to construct a tourist attraction on federal land, a ground lease can be the only way to do it. Although it might seem odd at first for a developer or tenant to construct a building on land that is owned by someone else, there are good reasons why a ground lease is advantageous to all parties involved. A ground lease also helps a tenant to focus on taking out loans to make improvements on the land and begin doing business instead of being bogged down by the cost of land acquisition.

Perhaps the biggest advantage for tenants is that a ground lease provides access to well-located land that otherwise could not be bought. This is why ground leases are widely used by many big retail tenants such as McDonald’s, Chick-fil-a, and Starbucks. Another advantage of a ground lease is that the tenant does not have to come up with the upfront cash required to purchase the land in a deal. This lowers the upfront equity required in an investment, freeing up cash for other uses, and also improving the yield.

The lender may also opt to have a fixed percentage increase periodically. Another common option the lender may do is to reset the rent costs every 10 to 20 years. You can access all of and the course catalog, but you will be unable to make online purchases or change account settings. • Must pay for any land improvements themselves.• Lose improvements to land after lease expires if they don’t renew or buy. Pros Cons • Avoids the large upfront capital expenditure of buying land. • Decades-long leases and the ability to renew the lease or buy the property at lease expiration. Further, he does not have to worry about the hassle of making improvements on the land, which a tenant does.

Since this type of leasehold is risky, the landlord may demand for rent fee increases for the land lease. Also, the landlord may impose stricter control on lease transactions with the tenant. Typically, a tenant would also borrow money to finance the construction for the improvements on the leased land. As a result, the tenant may partner up with a land developer for a construction loan. Like an ordinary lease, there are two parties involved – the lender or the landlord/real property owner, and the lessee or the tenant. A subordination agreement is often required to get the construction project moving, but it represents a real risk for the landowner.

In this article we’ll shed some light on how ground leases work, explain what typical ground lease structures look like, and we’ll also clear up some common misconceptions about the ground lease. In a subordinated ground lease, the landowner gets a lower priority on claims on the land in question by agreeing to such terms. Here the owner allows the mortgage of the land to the lender whose rights remain overriding to the owner. Ultimately, benefits of a land lease depend on a variety of different factors and calculations. Before creating an agreement, all parties must weigh in all possible outcomes and consider if a ground lease is the overall best option for all involved parties. Both the property owner and the lessee may need to involve different professionals, but given the numerous benefits of a ground lease, it may be the best solution for your real estate needs. This type of leasehold agreement also helps both the lender and the tenant save on real estate taxes.

During the beginning stages of a ground lease, the landowner and future tenant create an agreement allowing the tenant to begin leasing land for their new build. Typically, these leases are long-term, lasting anywhere between 50 to 99 years and once the lease expires, the landowner is generally given ownership to the building. As owners and operators of retail shopping centers, one of the things that we like to do to add value to our assets is to enter into ground leases for the development of our property’s outparcels. This provides an additional stream of steady income for us and the parcel – once developed – can increase the market value of our existing commercial property. There are two types of ground leases in commercial real estate, subordinated and unsubordinated. A typical land lease involves a piece of land that is either in a highly desirable location or has some sort of distinguishing feature that would make it incredibly difficult to replicate.