With this unique kind of lease, tenants are given permission to develop the land over the course of the lease. A ground lease is more common with commercial properties. Once the rental terms are over, both the land and any developments are returned to the owner. Because a ground lease allows for land development, from a legal, financing, and deal perspective, it’s more akin to real property acquisition than it is to a lease.
Careful consideration should be given to the terms of the deal and the scope of the due diligence undertaken in order to ensure that the lease will be a good fit for your long-term business needs and acceptable to your construction lender.
Ground Lease Terms and Title
A ground lease typically lasts 50 to 99 years, but should be no shorter than the time needed to fully amortize the costs associated with your construction or improvements.
Make sure to review the property’s title as if you were purchasing the land. (We recommend that you request a Leasehold Title Policy Commitment and obtain a title insurance policy covering your leasehold interest, provided such policy is available in the state where the property is located.) If you do not have legal counsel—which we recommend you do—a few items to consider include:
- The title company should deliver copies of all documents referenced in the commitment.
- The entity or individual listed as the grantee on the last deed of record should match the entity named as landlord on your ground lease. Even minor variations in the name (such as missing commas or a different entity type being listed) can prove problematic. Double-check the correct entity name and the status of that entity with your Secretary of State.
- Make sure that the title premium is paid and the title company delivers the leasehold title policy once the lease is executed. The insured party should be the tenant entity listed in the lease and any guarantor required by the lease.
- Review applicable mortgage documents listed on the commitment to determine if lender approval of the ground lease is necessary. Existing loans will need to be subordinated to the ground lease, and those documents recorded in the real property records in the county in which the property is located. An attorney can assist you with preparing the appropriate subordination forms.
After rental, record a Memorandum of Ground Lease or Short Form Ground Lease—depending on location—in the real property records to provide notice to future lenders or potential purchasers of the property of the existence of the ground lease.
Reviewing the Survey, Zoning, and Condition of the Property
As previously mentioned, the type of due diligence being undertaken prior to entering into a ground lease is similar to a property acquisition. Major review items include:
- Survey: Complete and review an ALTA survey of the property before executing the lease. Pay attention to existing utility facilities and public rights, and compare them to the proposed construction plans.
- Zoning and approvals: Confirm applicable zoning designations and regulations with the city planning and zoning department. If the current zoning doesn’t permit your planned use, you will need to seek a zoning variance. The lease documents should allow you to terminate the lease if the correct zoning or city approvals aren’t acquired.
- Environmental/Condition of Property: Complete a Phase I and Phase II investigation of the property, as well as an on-site inspection.
Ground Lease Negotiation Considerations
It is often appropriate to request a Right of First Offer or Right of First Refusal from the owner, and this should be negotiated at the letter of intent stage. Additionally, negotiate the condition of the improvements at the end of the term and how title to the improvements will be transferred. Will they be provided as is, or without warranty? Will you have any obligation to remove or restore them?
Typically, rent is either tied to the market or determined up front for the entire term fo the lease. If you’re using market rents, make sure to carefully craft the terms of how “market” will be determined. Will rent be based on the then-current use of the premises, which is favorable to investors, or based upon the then highest-and-best use, which is less favorable?
Additionally, ensure that the lease allows for easy assignment and subletting to third parties.
