A ground lease is a long-term agreement in which a tenant leases land from a property owner and typically develops or uses the land for a specific purpose.
Unlike a traditional lease, where the tenant usually rents a building or other structure, a ground lease primarily concerns the land itself. The tenant may construct a building or other improvements on the property while the landlord continues to own the underlying land.
Ground leases are commonly used for commercial real estate, including office buildings, retail properties, restaurants, hotels, and other developments.
The structure can be attractive to both parties. The landowner can generate income without selling the property, while the tenant may be able to develop a property without purchasing the land outright.
How Does a Ground Lease Work?
Under a ground lease, the landowner, or lessor, allows a tenant, or lessee, to use a parcel of land for an agreed period.
The tenant pays rent according to the terms of the agreement.
Depending on the lease, the tenant may be responsible for:
- Developing the property
- Constructing buildings or improvements
- Obtaining permits
- Maintaining the property
- Paying property taxes
- Paying insurance
- Paying utilities
- Maintaining landscaping and other site improvements
The landlord generally retains ownership of the land.
For example, imagine a developer wants to build a retail property on a valuable piece of land but doesn’t want to purchase the land.
The developer could enter into a 50-year ground lease with the landowner.
The developer builds and operates the retail property while paying rent to the landowner.
The exact rights and responsibilities depend on the ground lease agreement.
How Long Does a Ground Lease Last?
Ground leases are generally much longer than ordinary residential or commercial leases.
They can last for several decades, with terms of 30, 50, 75, or even 99 years depending on the agreement.
The long lease period gives the tenant enough time to justify investing significant money in construction and development.
For example, a developer is unlikely to spend millions of dollars constructing a building if the lease expires in only a few years.
A long-term ground lease provides more time to recover the development costs and generate a return on the investment.
The lease may also contain renewal options that allow the tenant to extend the agreement.
What Is the Difference Between a Ground Lease and a Regular Lease?
The main difference is what the tenant is leasing.
A traditional commercial lease generally involves renting an existing building or a portion of a building.
A ground lease primarily involves leasing the land.
For example:
Traditional commercial lease: The tenant rents a storefront in a shopping center.
Ground lease: The tenant leases a parcel of land and may construct and operate a building on it.
A ground lease therefore separates ownership of the land from the ownership or use of improvements constructed on the land.
What Is a Ground Lease in Commercial Real Estate?
Ground leases are particularly useful in commercial real estate because land can be expensive.
Instead of purchasing a property outright, a business or developer can lease the land and invest its capital into developing the site.
Consider a developer that wants to build a $10 million commercial property on a valuable parcel of land.
Purchasing the land might require several million dollars in additional capital.
With a ground lease, the developer may be able to use that capital for construction and operations while paying the landowner periodic rent.
This can change the economics of a development project significantly.
Types of Ground Leases
Ground leases can be structured in different ways.
Two common categories are subordinated and unsubordinated ground leases.
Subordinated Ground Lease
Under a subordinated ground lease, the landowner agrees that the tenant’s lender can have a claim against the land in certain circumstances.
This can make it easier for the tenant to obtain financing for construction or development.
Because the lender receives greater protection, the arrangement may make the project more financeable.
However, the exact rights of the landlord, tenant, and lender depend on the agreements involved.
Unsubordinated Ground Lease
An unsubordinated ground lease generally gives the landowner greater protection.
The landlord retains priority over the tenant’s financing interests in the land.
This can make the arrangement less risky for the landowner, but potentially more difficult for the tenant when obtaining development financing.
The specific terms of the ground lease and lender agreements are critical.
Who Pays Property Taxes on a Ground Lease?
The tenant often pays property taxes under a ground lease, but this isn’t automatic.
The lease should clearly state which party is responsible for:
- Property taxes
- Insurance
- Maintenance
- Utilities
- Repairs
- Improvements
- Other operating expenses
In many commercial ground leases, the tenant takes on substantial responsibility for the property.
This can make the arrangement similar to a net lease in terms of expense allocation.
However, a ground lease and a net lease are not the same thing.
A ground lease describes what is being leased—the land—while a net lease describes how certain expenses are allocated between the landlord and tenant.
What Happens to the Building at the End of a Ground Lease?
This is one of the most important questions to answer before entering a ground lease.
The lease should specify what happens to buildings and other improvements when the agreement ends.
Depending on the contract, the improvements may:
- Become the landlord’s property
- Need to be removed by the tenant
- Remain subject to a renewal agreement
- Be handled according to a negotiated purchase or transfer arrangement
For example, if a tenant spends millions of dollars constructing a building on leased land, the tenant needs to understand whether that building can remain after the ground lease expires.
A well-drafted ground lease should clearly address ownership and treatment of improvements at expiration.
Advantages of a Ground Lease for Tenants
Ground leases can provide several benefits to tenants and developers.
Lower Initial Land Acquisition Cost
The tenant doesn’t have to purchase the land outright.
Instead, the tenant pays rent over the lease term.
This can reduce the amount of capital required to start a development project.
Access to Valuable Locations
A ground lease can allow a business to operate on land that might otherwise be too expensive to purchase.
This can be especially valuable in high-demand commercial areas.
Capital Can Be Used for Development
Instead of tying up capital in land acquisition, a developer may be able to use more of its available capital for construction, equipment, operations, or other business needs.
Long-Term Control
A long-term ground lease can give the tenant substantial control over the property for decades, subject to the lease terms.
This can provide enough time to develop and operate a commercial project.
Advantages of a Ground Lease for Landlords
Ground leases can also be attractive to landowners.
Retain Ownership of the Land
The landlord continues to own the underlying land rather than selling it.
This allows the owner to retain a long-term interest in the property.
Generate Rental Income
The landlord receives rent throughout the lease term.
Depending on the agreement, the rent may increase periodically through scheduled increases or other mechanisms.
Potential Long-Term Appreciation
The landowner retains ownership of the land, meaning the land may continue to have value as the surrounding area develops.
Reduce Development Responsibilities
If the tenant is responsible for construction, maintenance, taxes, and other expenses, the landowner may be able to generate income without directly developing or managing the improvements.
Disadvantages of a Ground Lease for Tenants
A ground lease isn’t necessarily cheaper or easier than buying land.
There are several risks to consider.
You Don’t Own the Land
The tenant has the right to use the land under the lease but doesn’t own the underlying property.
This can limit the tenant’s control compared with outright ownership.
Rent Can Increase
A ground lease may contain rent escalation provisions.
If rent increases significantly over time, the property’s operating economics can change.
Financing Can Be More Complicated
Lenders may carefully examine the ground lease before financing construction on leased land.
The lease needs to provide sufficient rights and protections for the lender.
Improvements May Be at Risk
If the lease ends without a renewal or purchase arrangement, the tenant may lose some or all of its investment in improvements depending on the contract.
This makes the expiration provisions extremely important.
Disadvantages of a Ground Lease for Landlords
Landowners also take on certain risks.
Long-Term Commitment
A ground lease can last decades.
The landlord may have limited ability to change how the property is used during the lease term.
Tenant Default
If the tenant stops paying rent or violates the agreement, the landlord may have to deal with enforcement and potentially complicated issues involving buildings and financing.
Development Risk
If the tenant fails to complete the planned development, the landowner may end up with a property that doesn’t meet expectations.
The lease should establish development requirements and remedies for failure to meet them.
How Is Ground Lease Rent Determined?
Ground lease rent depends on several factors.
These can include:
- Land value
- Location
- Property use
- Development potential
- Lease term
- Market rental rates
- Rent escalation provisions
- Tenant improvements
- Creditworthiness of the tenant
For example, land in a prime commercial area may command substantially higher ground rent than a similar-sized parcel in a less desirable location.
Ground leases may also include periodic rent increases.
Some agreements use fixed increases, while others may use adjustments tied to an index or changes in property value.
Ground Lease vs. Land Lease
The terms “ground lease” and “land lease” are often used interchangeably.
Both generally refer to an arrangement where a tenant leases land rather than purchasing it.
However, the specific structure can vary.
A ground lease in commercial real estate often involves a long-term arrangement under which the tenant develops or operates improvements on the land.
The actual lease agreement determines the rights and obligations of each party.
Ground Lease vs. Triple Net Lease
A ground lease and a triple net lease are different concepts.
A ground lease determines the property interest being leased.
A triple net lease, or NNN lease, generally refers to a lease structure where the tenant pays base rent plus property taxes, insurance, and maintenance or operating expenses.
A ground lease can include net lease characteristics.
For example, a tenant leasing land under a ground lease might also be responsible for taxes, insurance, maintenance, and other expenses.
But not every ground lease has exactly the same expense structure.
What Should a Ground Lease Include?
Because ground leases can last for decades and involve significant investments, the agreement needs to address much more than rent.
Important provisions can include:
- Lease term
- Renewal options
- Rent amount
- Rent increases
- Permitted property use
- Development requirements
- Construction standards
- Maintenance obligations
- Property taxes
- Insurance
- Financing rights
- Assignment and subleasing
- Default provisions
- Eminent domain
- Casualty and condemnation
- Environmental responsibilities
- Ownership of improvements
- Sale or transfer rights
- End-of-lease requirements
The more money being invested in the property, the more important these provisions become.
What Happens When a Ground Lease Expires?
The outcome depends on the agreement.
A ground lease may provide for:
- Renewal of the lease
- Transfer of improvements to the landlord
- Removal of improvements
- Negotiation of a new lease
- Purchase of the property
- Other agreed arrangements
The tenant should understand the expiration provisions before investing substantial money in construction.
Imagine spending $5 million developing a property only to discover that the lease requires the improvements to be transferred to the landlord when the lease ends.
That possibility needs to be considered when calculating the project’s expected return.
Is a Ground Lease a Good Investment?
A ground lease can be attractive to investors and landowners because it can provide long-term rental income while allowing the owner to retain the underlying land.
For tenants and developers, a ground lease can provide access to valuable land without requiring an outright purchase.
But whether a ground lease is a good investment depends on the specific economics.
Consider:
- Land value
- Ground rent
- Rent increases
- Lease duration
- Development costs
- Financing terms
- Expected property income
- Remaining lease term
- Value of improvements
- Exit strategy
A project that looks attractive at today’s rent may become less attractive if ground rent increases significantly over time.
Frequently Asked Questions
What is a ground lease in simple terms?
A ground lease is an agreement in which a tenant leases land from a landowner, usually for a long period. The tenant may develop or use the land while the landlord retains ownership of the underlying land.
How long does a ground lease last?
Ground leases are often long-term agreements that can last 30, 50, 75, or 99 years, although the actual term depends on the contract.
Who owns the building in a ground lease?
Ownership depends on the lease agreement. The tenant may own the improvements during the lease term, but the agreement can specify what happens to them when the lease ends.
Who pays taxes on a ground lease?
The tenant often pays property taxes, but responsibility depends on the lease. Always check the expense provisions in the agreement.
Can you finance a property on a ground lease?
It may be possible to finance development on leased land, but lenders typically examine the ground lease carefully. The lease may need provisions protecting the lender’s interests.
Is a ground lease the same as a land lease?
The terms are often used interchangeably. Both generally refer to leasing land rather than purchasing it, although specific lease structures can differ.
The Bottom Line
A ground lease allows a tenant to use land without purchasing the land outright. The arrangement is particularly common in commercial real estate, where developers may want to build and operate properties on valuable land without acquiring it.
The tenant may be responsible for development, taxes, insurance, maintenance, and other expenses, while the landowner retains ownership of the underlying land.
The biggest issues to understand are the lease term, rent increases, financing rights, development obligations, and what happens to the improvements when the lease expires.
Because ground leases can involve decades-long commitments and substantial investments, both landlords and tenants should carefully review the agreement and consider obtaining professional legal and financial advice before signing.