Lease Agreement for Land Surface: Meaning, Illustration, Advantages and Disadvantages
There are various sorts of business leases. For instance, a gross lease necessitates regular rent payments from the tenant, making this their sole financial commitment to the landlord. This is much like the lease you'd sign when renting an apartment. Conversely, single-, double-, and triple-net leases transfer certain expenses, such as property taxes and insurance, to the tenants.
Generally speaking, these leases involve a landlord who owns a commercial building and a tenant who pays monthly rent and doesn't have any ownership rights.
There's another type of business lease called a ground lease, which is a bit different. Under a ground lease, tenants own their building, but not the land it's built on. In this sort of leasing arrangement, an undeveloped commercial land is leased to tenants, who then have the rights to develop and use the property for the duration of the lease.
During the term of a ground lease, the tenant owns any improvements made to the property, including any buildings constructed. For example, many Macy's departments stores are ground-leased, which means that Macy's owns the building itself and any other improvements made to the land – say, parking structures – but the company still pays rent on the land beneath the store.
Just like most other real estate leases, ground leases require tenants to make regular (usually monthly) rent payments. And ground leases are usually net leases, which means that tenants are responsible for paying property taxes, insurance, and maintenance expenses for the duration of the lease.
Ground leases tend to have lengthy terms – 20 to 40 years is common for an initial term, but ground leases up to 99 years aren't uncommon. Improvements made to land that is ground-leased become the property of the landlord after the lease expires, or the tenant might be required to demolish them. So why would anyone want to construct a building unless they could use it for a long time?
To summarize, in a ground lease:
- The tenant pays rent on the land but owns the buildings and other structures/improvements.
- The tenant is responsible for paying property taxes, insurance, and maintenance expenses.
- The lease is typically for several decades at a minimum.
- After the lease expires, any buildings or other property improvements belong to the landlord.
Real-world example
A real-world example of a ground lease situation
In the realm of real estate investment trusts, or REITs, American Tower is an example of a company that typically uses ground leases. The company owns and operates communications towers (like those that power your mobile phone's network), but in most cases, it doesn't own the land the towers are built on.
Specifically, American Tower has ground leases on about 90% of the towers in its portfolio, and it has over 35,000 separate landlords. American Tower's ground leases typically have initial five- to 10-year terms, but instead of letting any of its leases expire, the company's general practice is to either extend the lease or buy the land to terminate the ground lease.
This is a beneficial business model for the company (and its landlords) for a few reasons. First of all, it allows American Tower to expand without the massive capital outlay that would come with acquiring the land to build thousands of towers. It also has tax benefits since the eventual lease buyouts gradually turn operating expenses into capital expenditures, which are generally better for ongoing tax purposes. From the landlord's perspective, they get to collect decades of worry-free income and eventually (in many cases) get a lump-sum payment for the property.
Avoids the large upfront capital expenditure of buying land.
Subordinated vs. unsubordinated
Subordinated vs. unsubordinated ground leases
Must pay for any land improvements themselves.
There are two main types of ground leases: subordinated and unsubordinated. And the difference is what happens if a tenant runs into financial trouble during the lease term.
- Subordinated ground lease: In a subordinated ground lease, the tenant agrees to be a lower priority when it comes to any other financing the tenant obtains on the property. For example, let's say you sign a ground lease on a parcel of land and then borrow $500,000 to build a restaurant. If you default on the loan while under a subordinated ground lease, your lender can go after the property (including the land) as collateral.
- Unsubordinated ground lease: On the other hand, in an unsubordinated ground lease, the tenant has a higher priority than any other lenders when it comes to claims on the property. In other words, the tenant's lenders may not foreclose on the land if they default. In the event of default, a lender on a property in an unsubordinated ground lease may be able to go after the assets of the business but cannot take full control of the property as they may be able to in a subordinated ground lease.
With all things being equal, landlords would want to sign unsubordinated ground leases. After all, why would a landlord want to risk their property?
In practice, landlords generally have to charge lower rent on unsubordinated ground leases to entice tenants to accept such an arrangement. Many lenders won't originate loans to build commercial buildings on ground leases unless they have the recourse to take control of the property in the event of the tenant's default.
Decades-long leases and the ability to renew the lease or buy the property at lease expiration.
Unsubordinated ground leases are the more common arrangement. Even though they generate less rental income, landlords typically don't want to put their property at risk, essentially taking an active stake in the tenant's business.
Related financial investments
Lose improvements to land after lease expires if they don't renew or buy.
Investing in Construction Company Shares
These typically stable and gradual investments can create wealth in the long run.##### Investing in Transportation Company Shares
Businesses that facilitate the movement of people and goods are the focus of these entities.##### Investing in Manufacturing Company Shares
Manufacturing companies span various economic sectors that they support.##### Investing in Defense Industry Shares
Reduced lease payments, as opposed to leasing both land and a building.
As the U.S. continues to strengthen its defense budget, defense industry's most promising stocks appear more alluring.## Advantages of Ground Leases
What are the advantages of Ground Leases?
Responsible for paying property taxes, insurance, and maintenance expenses for the duration of the lease. May need landlord approval before construction can begin.
From a landowner's viewpoint, there are numerous reasons why a Ground Lease might be favorable, such as avoiding the substantial capital outlay required for property development or selling land outright. Developing commercial buildings can be capital-intensive. Ground Leases provide commercial landowners with a method to monetize their real estate without requiring significant capital investment.
Moreover, Ground Leases allow landowners to retain ownership of the property. This can be vital in circumstances where land is owned by a government entity but can also be beneficial in numerous situations. For instance, if you wish to create a tourist attraction on federal land, a Ground Lease may be the only viable option.
Finally, as I mentioned earlier, any improvements become the property of the landowner upon the conclusion of a Ground Lease, so the property's value could significantly increase beyond its initial worth at the time of the agreement's inception.
Tenants may favor Ground Leases as constructing a building is less costly than purchasing land and then building a building. Many retailers employ Ground Leases for this reason - they cannot justify or afford the cost of a building and the land. Fast-food restaurants commonly lease their land but construct their buildings themselves as an example.
Additionally, a tenant can often save money on their recurring rent payments by signing a Ground Lease instead of leasing an entire improved property.
Pros and cons of Ground Leases: A Tenant's Perspective
| PROS | CONS || --- | --- || Avoids the substantial upfront expense of purchasing land. | Must fund land improvements themselves. || Offers the potential for long-term leases or lease renewal/purchase options at lease expiration. | May lose improvements to land after lease expiration if they don't renew or buy. || Lower lease payments, as opposed to leasing both land and a building. | Responsible for paying property taxes, insurance, and maintenance expenses for the duration of the lease. May require landlord approval before construction can commence. |
Conclusion
Ground Leases may not be the ideal option in all cases. For example, since they lease land, tenants may need a landlord’s approval before construction can begin. Tenants may lose control of their building after the lease term expires.
However, a Ground Lease can be a mutually beneficial arrangement for many landowners and commercial tenants, which is why they are common in practice. They enable landlords to maintain ownership and generate a steady income, while also enabling commercial tenants to establish a business location without the additional upfront expenditure of purchasing land.
Matt Frankel has no position in any of the companies mentioned. Our Website has positions in and recommends American Tower. Our Website recommends the following options: long January 2026 $180 calls on American Tower and short January 2026 $185 calls on American Tower. Our Website has a disclosure policy.
In the context of real estate investment trusts, companies like American Tower often use ground leases for their communications towers, as they do not own the land the towers are built on, but have long-term ground leases with multiple landlords. This business model allows American Tower to expand without a large upfront capital expenditure and has tax benefits for the company.
For investors, ground leases can be an attractive option, particularly in the case of construction company shares. Investing in construction companies can create wealth in the long run, as these companies often benefit from ground lease arrangements, which provide a steady stream of income for property development.
In summary, investing in realistic scenarios that involve ground leases can be advantageous, whether for companies like American Tower or for investors looking for stable, long-term returns.
