Ground Lease

From CEOpedia | Management online

The ground lease is a long term agreement in which the uncertainty of the future results that may affect the value of the contract for the sides involved. Usually, the landowner (also called ground lessor) leases land to a ground developer (ground lessee) for a long time, typically over thirty years. The ground lessee manages the land in an agreed way and the lessor and lessee share the arisen cash flows. At the end of the lease, the improvements return to the landowner. It is significant for the landowner to conclude the contract that encourages the land tenant to make the net present value of the underlying assets as large as possible at the beginning and throughout the lease term, due to the long term nature of the lease (D. Johnson 2001, p. 2).

Generally, ground leases allow using the land of other people to raise a building. As the result, the owner of the land and buildings is divided. To use the land, the proprietor of the construction has to pay to the owner of the land an annual leasehold fee. The leasehold right can be sold or inherited as a counterpart of full real property (D. Löhr 2017, p. 281).

The land lease agreement transfers the right to improve, occupy and use the land (leased fee interest) to a lessee subject to the obligations and restrictions imposed by the lessor who holds reversible shares in the land. Although a lease instead of buying land allows developers to provide a complete product for less amount of money, the lease agreement must provide adequate financial retribution to the developer and potential buyers to devote time, effort and capital to initiating and preserving land improvements. On top of it, the rental period must be long enough to allow mortgage financing for a person or group besides the two primarily involved in a situation (T. Tyvimaa, K. M. Gibler, V. Zahirovic 2015, p. 2).

Use of ground leases

Most of the time ground leases are used for:

  • Retail
  • Office
  • Industrial developments

Furthermore, building private homes on leased public land as a means of realization of land use policy is common in some countries and cities, including Amsterdam, Hong Kong, Stockholm, Israel, Japan, and Finland. However, this occurrence is still new and the impact of such land lease agreements has not yet been well established (T. Tyvimaa, K.M. Gibler, V. Zahirovic 2015, p. 2).

Rent reset clause

Every few decades rent should adapt to changes in the real estate market. This requirement resulted in a "rent reset" clause. At the initial closure, the parties cannot predict the value for 20 or 30 years. Consequently, the formula needs at some point to reflect the market value and everything the landlord has provided for the transaction. Usually, the formulas look at the leased land in the moment of adjustment and then multiply it by a fixed percentage (6 to 7 percent) or a percentage that depends on the current interest rate. As a result, a new annual rent for the land is created. Until then, rents may increase by formal "bumps" every few years. The problem is will the rent reflect just the value of the land? Or will it also mirror the value of buildings the developer has built on it? The rent should compensate the owner only the value of the land, not the project, because most often, the parties sign the contract before the developer builds the project (J. Stein 2007, p. 129).


Ground Lease — recommended articles
Long term lease — Cash bond — Depreciation vs. amortization — Lease Extension — Depository bond — Demand loan — Non current liability — Interim financing — Residual payment

References

Author: Weronika Piotrowska

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