Why Property Owners Elect to Ground Lease

Ground leasing is a long term, often very long term, net lease of real estate. Ground leases are used for both improved parcels and development parcels. A long term lease like a ground lease has a few disadvantages including:

  • A lack of control - the tenant under the lease usually has wide discretion in operating the property.
  • A sharing of the economic benefits relating to the property. The ground lease typically provides for fixed rent payments to the landlord, adjusted periodically, while the tenant gets the potentially greater long term economic upside, at least until the next ground rent reset.
  • The tenant could mismanage the property and then default on the rent leaving the landlord in a difficult spot.

So why are ground leases popular?

  • Despite the complexity and risk, the owner retains ownership of the property and avoids a large tax on a sale.  While an exchange qualifying under Section 1031 of the tax code offers a tax deferral mechanism, it's hard to find satisfactory replacement real estate in the time periods required under 1031.
  • These days, alternative investments offer meager returns particularly after the taxes are paid out of the sale proceeds. 
  • Keeping it in the family - as my partner Sam Ross said the other day: "it is a way for families to think generationally where they can stick together and have a bond-like steady income. Once the proceeds of a sale get distributed to all the heirs, the money seems to drift away especially if the heirs have the Midas touch in reverse."
  • Management of a ground lease is simple. A landlord needs to manage the rent adjustment mechanism and that's about it. 

The biggest current issue in ground leases is the traditional ground rent reset mechanism. Market trends have made the reset mechanism fraught with peril. But that will be the subject of another post. 

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