Acquiring property without buying it outright sounds too good to be true—until you learn about ground leases. For investors looking to build without spending millions on land, or landlords who want a more passive investment, this kind of lease could be the golden ticket. But what is a ground lease, and is it the right move for your project?
In this guide, we break down what a ground lease really means, how it works, the pros and cons for both the investing tenants and landlords, and the key things to consider before signing on the dotted line. Let’s make sense of it together.
Main Takeaways
- What is a ground lease? Ground leases let tenants develop land without owning it, offering benefits like lower upfront costs but posing risks such as rising rent and loss of improvements.
- Meanwhile, landlords gain steady income but face challenges, including tenant defaults, limited control over property changes, and delayed profits.
- Understanding lease terms is crucial, as the structure—subordinated or unsubordinated—determines financial risks and legal protections for both parties.
What Is a Ground Lease?
A ground lease is an agreement that lets a tenant lease land and develop it during a set period—usually for 50 to 99 years. The investor builds on the land, uses it, and then returns both the land and any improvements (like buildings) back to the owner when the lease ends. As a property management company in Philadelphia, we often refer to these as land leases because only the land is being leased, not any buildings on it.
How Does a Ground Lease Work?
Just like a normal lease, the tenant in a ground lease is allowed to build on the land and use it for a certain number of years, but they don’t actually own the land. Also, they’re usually responsible for paying all its taxes and handling all its maintenance. Furthermore, unless there’s a special agreement that says otherwise, anything the tenant builds on the land will belong to the landowner once the lease ends.
Then, after the lease ends, the landlord may be able to sell the property at a higher price because they eventually own all the improvements made on the property.
Although ground leases are often used in commercial real estate, that’s not always the case. Some people also use them for residential real estate purposes.
The 2 Types of Ground Leases
In most cases, ground lease tenants borrow money to develop the land they’re leasing. But here’s where it gets interesting: not all ground leases treat that loan the same way.
There are two main types of ground leases, and the difference comes down to one big question—can the tenant use the land as collateral for a loan, or not?
Let’s break down each type and what it means for both the tenant and the landlord.
1. Subordinate Ground Lease
A subordinated ground lease basically means the landlord agrees to be second in line if things go sideways financially. That sounds simple, but what does that actually look like in real life?
Let’s say a tenant wants to lease a piece of land and build something big, like a hotel or a shopping center. To do that, they need a loan from the bank. But the bank says, “If this goes wrong, we want to be first to take the property and sell it to get our money back.”
Normally, the landlord would be first in line since they own the land. But in a subordinated lease, the landlord lets the bank have the first pick. So, if the tenant can’t pay back the loan, the bank gets control before the landlord does.
It’s definitely a risk for the landlord, but they’re usually willing to take that chance—especially if the project has the potential to really boost the value of their land. And because they’re taking on more risk, it’s common for them to ask for higher rent to balance things out, just in case the tenant ends up defaulting.
2. Unsubordinated Ground Lease
An unsubordinated ground lease is the safer option for the landlord. In this case, the landlord stays first in line if things go wrong financially.
So, if the tenant takes a loan to build something on the land and then fails to repay it, the bank can’t take the land because the landlord still has top priority. The bank can only go after the building or improvements, not the land itself.
Because of this, banks might be more cautious about giving the tenant a loan—they don’t want to risk losing money if the tenant defaults.
To make up for that risk, the landlord often has to charge less rent to attract tenants who might have a harder time getting a loan.
Pros and Cons of a Ground Lease
A ground lease comes with its fair share of benefits for both the tenant and the landlord. But like any agreement, it also has a few drawbacks. Let’s break it down and look at each side separately:
Pros for Tenants
- Access to Prime Locations: As we’ve already seen, these leases often involve prime land in commercial areas. This gives tenants the chance to build in valuable, high-demand locations—without needing to buy the land outright.
- No Down Payment Needed: Unlike buying land, ground leases don’t usually require a big down payment. This makes it easier for the tenant to get started on developing the property. After all, the bar to entry can be lower.
- Tax Benefits: The rent tenants pay on a ground lease may be tax-deductible. If the tenant meets certain requirements, like having a lease of at least 15 years, they may be eligible. So, that can help them lower their overall state and federal income taxes.
Cons for Tenants
- More Restrictions: The lease terms tenants must follow for ground leases are usually strict. In that vein, they typically will need the landlord’s approval for certain decisions, especially with major improvements. Also, zoning laws or historical preservation regulations may come into play. So, those can be significant limitations.
- Can Get Costly: Sure, ground leases are easier on the wallet at the start compared to buying land, but the costs can creep up. Rent, taxes, building expenses, permits, and even the time it takes to get the landlord’s approval, can all start adding up as the project moves along. Particularly concerning the rent, your landlord may raise the rent throughout the years. And those increases may outpace market rates. In the end, it might be more expensive to rent than it would be to own a property outright.
- The Tenant Doesn’t Own the Land: The tenant won’t gain equity in the land, only potentially in whatever they build. Although they can develop and improve the property, those investments aren’t the same as ownership. When the lease ends or if the landlord breaks it, they may take control of those improvements–without compensating the tenant who made them in the first place.
- Ongoing Obligations: You may be responsible for property taxes, maintenance, and insurance, even though you don’t own the land. These costs can add up quickly and may rival what the tenant would pay if they owned the property. And, again, tenants typically don’t receive long-term financial advantages from these investments because they don’t own the property.
- Financing Challenges: Lenders may be hesitant to fund projects on leased land, so it could be harder to secure financing. Also, many banks view ground leases as riskier compared to fee-simple ownership, so they may demand higher interest rates or stricter lending terms. In the end, some lenders may outright refuse to finance properties on leased land. So, the tenant could have limited financing options.
Pros for Landlords
- Steady Income: With ground leases, the landlord can earn consistent income as the tenant uses the property for years at a time. So, it presents the opportunity for stable, predictable cash flow.
- Maintenance: While the landlord owns the land, they don’t have to do the hard work of developing it and managing it. They don’t have to make the difficult decisions and the day-to-day chores. Someone else will take care of increasing the land’s value. As you can imagine, this lets landlords have a more passive investment.
- Escalation Clause: If landlords include this clause in their lease, it would let them make rent increases over time. Furthermore, it gives the landlord the right to evict the tenant if they default on rent or break the terms of the agreement. So, landlords can have a safety net if economic conditions change, or the tenant’s reliability does.
- Tax Savings: Unlike selling the property, which may come with a hefty tax bill, leasing it out can offer potential tax advantages, depending on the situation.
- Retains Control of the Property: Since the landlord isn’t selling the land out, they can remain the legal owner. That means they’ll still have full control of the property once the lease period ends. They don’t have to give up that key stake.
Cons for Landlords
- It Can Be Risky: Especially with a subordinated ground lease, the landlord risks losing the property if the tenant defaults on a loan and the lender takes over. So, they have to weigh that risk. They must be confident their tenant is qualified to truly follow through, financially. After all, unlike traditional tenants, you don’t just have to worry about them damaging the property. You’re putting the fate of your property in their hands, period.
- Limited Control Over Improvements: Since the tenant will be handling development, the landlord may have little say in how the property is improved. If the tenant neglects maintenance or makes undesirable alterations, it can impact the land’s long-term value.
- Taxes on Rental Income: The rent a landlord receives is considered taxable income, so they’ll need to account for that when they file their taxes.
- Delayed Profits: Unlike selling property outright, ground leases provide income over time but don’t result in immediate lump-sum gains. Landlords must wait years—sometimes decades—to fully benefit from long-term appreciation.
- Legal Complexities: Drafting and enforcing ground lease agreements can be complicated. It requires extensive legal oversight. If the landlord and tenant have disputes over lease terms, rent escalations, or property responsibilities, they could get into messy, lengthy legal battles.
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To answer, “what is a ground lease,” it lets tenants lease land and develop it without owning the property. For them, it offers them access to prime locations and lower initial costs. On the other hand, it opens the door to risks such as rent increases, trouble finding financing, and losing their ownership of improvements.
Meanwhile, while landlords can stand to benefit from steady income and passive investment with ground leases, they also may encounter potential drawbacks. For example, they will have to wait a long time to re-take the property and reap the rewards of its boosted value. They also may have limited say over the improvements that go into enhancing that value. Also, the tenant could default on their rent or loans. So, it’s critical for tenants and landlords alike to think carefully before they move forward.
In the meantime, if you’re an investor who wants to run a rental property, we can help. Everyone knows that managing one is exceptionally stressful and time-consuming. It requires you to stay in touch with all your tenants, coordinate maintenance and repairs, make sure you’re complying with the law, draft airtight leases, collect the rent, deal with taxes, and more. And if you don’t do these tasks meticulously, your business could fall through the cracks. Most people simply don’t have the time to give property management the time it requires, and that’s why we step in for 6,000 rentals all over Maryland, Pennsylvania, Virginia, and other large locations. Want to have a more passive investment? Reach out to us today to get started.
