Is Ground Lease a Good Investment in 2021?

By  //  June 11, 2021

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There are different types of commercial leases in the United States. In most leases, a landlord is the owner of the property and a tenant who pays the landlord. In this article, we’re going to focus on the aspects of the ground lease.

We’re also going to see whether the investment is worthwhile. Let’s take a look.

What’s a ground lease?

A ground lease is a contract in which the property owner leases to a tenant some of the rights to own the real property he/she holds. The tenant holds the property during the lease term and maintains a level of control over the property. The rights include; constructing improvements, subleasing, obtaining lease mortgage and assigning.

During the duration of a ground lease, the tenants own all the improvements, including commercial buildings, parking structures. Like other leases, the tenant is expected to pay rent (probably monthly). The tenant is also responsible for paying for insurance and maintenance, property taxes and other expenses related to the property during the lease duration.

Ground lease duration is long term. Mostly, a 20 to40 year term is ideal for most investors. However, some ground leases in the United States can go for up to 99 years. Once the time lapses, the landlord takes over the land and all the improvements made3 on the land. The tenant may also decide to demolish all buildings or improvements.

 So, why would you want to construct a building and leave it to the landlord or demolish it?

Tenants may have the resources to appreciate a struggling piece of land. Most of them are developers in real estate, and they have a wide range of sources of capital and supply. If the size, development rights, and zoning resonate with the tenant’s preference, a ground lease is a way to go.

An example of a ground lease in the real world.

In the real estate investment space in the U.S, a couple of companies are investing in ground leasing. For example, the American Tower owns the building but doesn’t own the land. Two thirds of buildings believed to be owned by American Tower are ground leases. Instead of leaving the lease duration to expire, the company either extends the lease or acquire the land.

Advantages of ground leasing

Security

Landlords have the security of a long term income and appreciation of their property dues to developments. Improvements become the landlord’s property once the lease has ended unless otherwise stated in the agreement.

This helps the landlord increase the land’s value without contributing capital or expertise to do it alone. Due to the length of the contract, landowners have the security of receiving rent from a long-term tenant. The property can also be beneficial to heirs after the lease duration.

Tax advantages

Both the landlord and the tenant can benefit from a ground lease. As a tenant, you don’t have to pay land taxes, but you can deduct monthly rent on your taxes as part of business operating expenses. In exceptional circumstances like in municipal land, landlords can pay little or no taxes. Although the landowner is obligated to pay tax on property and rental income, many tax exemptions may apply.

For example, since the tenant will have improvements like building on the land, the tenant will take the depreciation deduction even if the landlord owns the land. Most states in the USA allow depreciation deductions. The depreciation deductions are used to compute the taxable income every year.

Capital gains tax is also another  form of tax that landlords can evade. It is derived from the proceeds of the sale of non-current assets. The land can avoid liability for capital gains taxes from profits he might have gained from the change of ownership rights.

There are also some deductible expenses. For example, suppose the contract states that the tenant is responsible for maintenance and repairs. In that case, they can deduct these expenses from their taxable income. As a tenant, you can also deduct rent as long as you’re operating a business. However, these deductible expenses depend on the state laws, so it’s advisable to check out the tax regulations in your area.

Protection from property fluctuations

Tenants are free from market fluctuations that come with owning a property. Even though you may not see the profits from appreciation, the property’s value comes from the profitability of your business. Tenants can also be protected from market fluctuations and inflation.

Financial benefits

A ground lease can be a perfect opportunity for you to operate a business on a parcel of land without purchasing it. You can invest your capital in developing the land or pay for other expenses instead of using the funds to purchase the land.

 However, a ground lease isn’t perfect in all circumstances. For example, you may need to get approval from your landlord before you construct a building. If the landlord disapproves, the tenant may lose control of the building once the contract lapses.

 The ground lease is a mutually advantageous contract for most landowners and tenants, which is why they have become more popular. They allow the landlords to have a steady income. On the other hand, tenants can acquire a space to run their businesses without buying land.

Bottom line

Is investing in ground leases worthwhile in 2021? The final decision depends on your preferences and factors like the amount of capital. Always conduct a cost0-benefit analysis and consult an expert in real estate before signing that ground leasing agreement.

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