Ground Lease

Definition of a Ground Lease

In commercial real estate, a Ground Lease is a long-term contractual agreement in which a tenant (the lessee) leases a plot of land from the landowner (the lessor) for a specific period, typically ranging from 50 to 99 years. Under this arrangement, the tenant generally constructs and owns the buildings and improvements on the land, while the landlord retains ownership of the underlying soil.

Detailed Description and Structure

A ground lease unbundles the ownership of the land from the ownership of the vertical improvements. This separation creates two distinct legal interests:

• Fee Simple Interest: The landowner’s interest in the property, which includes the right to receive rent and the reversionary right to take ownership of the buildings once the lease expires.
• Leasehold Interest: The tenant’s interest, which includes the right to use the land and the ownership of all structures built upon it for the duration of the lease.

For the duration of the lease term, the tenant is typically responsible for all property-related expenses, including real estate taxes, insurance, and maintenance costs. This is why ground leases are almost always structured as absolute net leases.

Ground Leases in Commercial Mortgages

From the perspective of a commercial lender, ground leases introduce specific complexities. When a tenant seeks a mortgage to build or renovate a property on leased land, the collateral for the loan is the leasehold interest rather than the land itself. This is known as a Leasehold Mortgage.

Lenders categorize ground leases into two primary types based on how they affect the mortgage:

• Subordinated Ground Lease: The landowner agrees to "subordinate" their interest in the land to the tenant’s mortgage lender. In the event of a foreclosure, the lender can seize both the building and the land. This is highly favorable to lenders but carries significant risk for landowners.
• Unsubordinated Ground Lease: The landowner does not provide the land as collateral. If the tenant defaults, the lender can only seize the leasehold interest (the building and the remaining time on the lease). This is more common in the modern market and requires the lease to be "financeable."

Key Financeability Requirements

For a commercial mortgage to be approved on an unsubordinated ground lease, the lease document must contain specific protections for the lender, often referred to as Lender Protections. These include:

• Notice and Cure Rights: The landlord must agree to notify the lender if the tenant defaults and allow the lender a period to "cure" the default to prevent lease termination.
• New Lease Provision: If the lease is terminated due to a bankruptcy or a tenant default, the landlord must agree to enter into a new lease with the lender under the same terms.
• Term Length: Lenders generally require the lease term to extend at least 20 to 30 years beyond the maturity date of the mortgage.
• Assignability: The tenant must have the right to assign the lease to the lender or a third party in the event of foreclosure without unreasonable restrictions from the landlord.

At the end of the ground lease term, ownership of the buildings typically transfers to the landowner at no cost. This is known as reversion. Because of this, the value of the leasehold interest diminishes as the lease approaches its expiration date, which is a critical factor in amortization schedules and loan-to-value (LTV) calculations for commercial mortgages.