A lease is a temporary conveyance of the right to use and occupy real property (land) in exchange for payment or rent. Black's Law Dictionary defines a ground lease as "a long-term (usually 99 year) lease of land only; such a lease typically involves commercial property, and any improvements built by the tenant usually revert to the landlord." Although many ground leases in the past were typically associated with 99 year terms, I have seen more current ground leases that have had terms from 5 to 6 years to 35 years.

Advantages and Disadvantages of Ground Leases for Landlords

Ground leases provide a number of advantages to a landlord. As previously mentioned, a ground lease will usually involve the tenant constructing improvements (i.e., buildings) on the land, and such improvements can be of great benefit to the landlord. First, the landlord may benefit from the anticipated appreciation in the land after the tenant builds improvements on the land. Since the landlord maintains ownership of the land, the landlord can pass on the appreciated value of the land to his estate or his heirs at his death.

Furthermore, the landlord may not have the knowledge and/or capital required to develop the land. A ground lease arrangement with a sophisticated tenant can result in development of the land in such a way as to maximize its potential. Additionally, a ground lease can provide a landlord with a stream of rental income.

There are also some disadvantages to a ground lease. Although the landlord might receive a stream of income from the ground lease, the rental income will be subject to taxation. Also, if the landlord changes its mind in the future and wants to sell the land, any preexisting ground lease may make it difficult to sell the land to a third party.

Advantages and Disadvantages of Ground Leases for Tenants

There are several advantages to ground leases for business tenants. For example, an owner may be unwilling to sell a particularly desirable tract of land. As a result, a ground lease allows the tenant to use the land and the owner to retain it's interest. Alternatively, a tenant may want to avoid tying up capital in a large land purchase. Leasing the land, as opposed to buying it, may free up the tenant's funds to build improvements or pay for other obligations.

What's more, albeit in rare situations, a landowner might be convinced to subordinate its interest in the land that is subject to the ground lease to the liens securing the tenant's construction financing for improvements. A landowner might do this so that the tenant will have a better chance of obtaining construction financing to build out whatever improvements the tenant has planned.

Owners of real property are often exposed to the significant risk of fluctuations in market value of their real estate. Tenants of ground leases will not be exposed to such risk. However, tenants of ground leases may also be disadvantaged by entering into a ground lease because a tenant will not own the property and will thus lose out on any gains in equity or market value of the property.

Conclusion

Although not as common in use as a typical landlord/tenant lease, ground leases can be both useful and practical in many types of business transactions. Having knowledge of the ground lease concept, as well as knowing when a ground lease might be an appropriate arrangement, could result in great economic benefits for both landlords and tenants.

Brett L. Slobin is an attorney in the Houston law firm of Slobin & Slobin , P.C. His practice focuses on commercial and residential real estate.