Ground leases, also known as land leases, may offer value to both business owners and landowners. But it’s essential for both parties to conduct due diligence before committing.
As vacant commercial lots become scarce and increasingly expensive to buy, commercial ground leases can present a solution for businesses in the retail and fast-food sector.
However, these long-term leases are not exclusive to today’s retail environment; they have been used for many years in agricultural, residential, and a variety of commercial applications.
Even with the possible disadvantages of long-term leases, commercial ground leases can be a great solution: Commercial complexes, recognizing that ground leases represent valuable commodities, have begun offering surplus space on their commercially zoned lots.
For their part, potential tenants appreciate the availability of affordable land. The result is the creation of a strong market that has the potential to benefit all parties.
However, both investors and landholders need to consider the following five components of commercial ground leases before entering into a binding lease agreement:
Term: The commercial ground lease term is anywhere between 10 and 99 years in duration. The longer time frame gives the potential tenant time to develop the land and maximize its potential.
Improvements: Typically, the tenant pays the cost of improvements with a commercial ground lease. This is not always the case, however, and it is a point that can be negotiated by both parties.
Tenants who need to build often see the cost of an annual long-term commercial ground lease as more affordable than purchasing a commercial lot to construct a new location, while landowners realize the added benefits of an improved lot: future value and an addition to their regular income stream.
Rent: Rental terms will require a skilled negotiator in order to maximize the value of a ground lease for all parties involved. The long duration of the lease terms means that landholders need to be creative about how they structure the lease costs.
Ultimately, if the tenant is covering the cost of improvements, they will expect low initial rents. However, as the value of the improvements depreciate, the rent should increase.
Tenant Financing: Commercial ground leases can be difficult to finance. Most developers need a certain amount of financing in order to construct a bricks-and-mortar store front.
Due to the fact that ownership of the property remains in the hands of the original landholder, financial institutions are reluctant to extend financing to the business owner/ developer without assurances from the leaseholder. This means there are substantial financial risks that need to be considered by all parties prior to finalizing the lease and financial terms.
Use: The use of the land is usually agreed upon when the lease is initially negotiated. Tenants will often require landlord consent in order to change or modify the use of the structure.
At the end of the project the tenant may have the right to renew, renegotiate or develop a new project.
The basis for these discussions should be clearly outlined in the initial lease terms.