Unsubordinated Ground Lease

Definition of an Unsubordinated Ground Lease

An Unsubordinated Ground Lease is a long-term real estate agreement in which a tenant leases land from a landowner (the fee owner) to develop or use a building on that site, but the landowner does not pledge the land as collateral for the tenant's mortgage. In this arrangement, the landowner’s interest in the property remains superior to the claims of any commercial lenders providing financing to the tenant.

Detailed Description and Mechanics

In a typical ground lease, the tenant owns the improvements (the buildings) while the landlord retains ownership of the land. When the lease is unsubordinated, it signifies a specific legal hierarchy regarding debt and foreclosure. If the tenant defaults on their commercial mortgage, the lender has the right to seize the leasehold interest—meaning the right to occupy the land and own the building for the remainder of the lease term—but the lender cannot seize or sell the underlying land itself.

From the perspective of a commercial mortgage, this structure creates a Leasehold Mortgage. Because the lender’s security is limited to the tenant's interest and does not extend to the fee simple ownership of the land, these loans are often viewed as higher risk than traditional mortgages or subordinated ground leases.

Key Features of Unsubordinated Ground Leases

• Priority of Claims: The landowner’s claim to the land is "first in line." Even if the tenant fails to pay their mortgage, the landlord’s ownership remains intact and unencumbered by the tenant's debt.
• Lender Protection Clauses: Because the lender cannot foreclose on the land, they will require specific leasehold protections in the lease document. These often include the right to receive notice of tenant defaults and the right to "cure" those defaults to prevent the lease from being terminated by the landlord.
• Lower Loan-to-Value (LTV) Ratios: Lenders typically offer lower loan amounts on unsubordinated ground leases compared to fee-simple properties because the collateral is deemed less secure.
• Reversionary Interest: At the end of the lease term, the ownership of the buildings and all improvements typically reverts to the landowner at no cost, free and clear of the tenant's mortgage.

Impact on Commercial Financing

For a developer or tenant, an unsubordinated ground lease is often less expensive to obtain initially because the landlord is taking less risk. However, it makes securing a commercial mortgage more complex. To make the lease "financeable," the document must be carefully drafted to ensure that the lender has the legal right to step into the shoes of the tenant if a default occurs, without the landlord terminating the lease and wiping out the lender's collateral.

Investors and lenders pay close attention to the term of the lease in these scenarios. Generally, the lease term must exceed the amortization period of the mortgage by at least 10 to 20 years to ensure the collateral retains value throughout the life of the loan.