GROUND LEASE

Contact Neufeld Legal for commercial leasing legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

A Ground Lease is a distinct commercial real estate lease arrangement, representing a long-term leasing agreement that fundamentally separates the ownership of the land from the ownership of the improvements (buildings, infrastructure, etc.) constructed upon that land. In its most common commercial form, a ground lease is a sophisticated financial and legal tool used primarily for the development of vacant or underutilized land in desirable locations.

A commercial ground lease is defined by the following core characteristics:

• Leasing the Land Only: The agreement exclusively involves the landowner (Lessor) leasing the raw land (or sometimes land with minor, existing improvements) to the tenant or developer (Lessee). The landlord retains the "fee simple" interest, meaning they own the underlying land forever.

• Long Term: Due to the significant investment required for development, ground leases are characteristically long-term, typically spanning 50 to 99 years. This extended duration is necessary to allow the tenant time to finance, construct, operate, and recoup their investment in the improvements.

• Tenant Development and Ownership (During Term): The tenant has the right (and often the obligation) to construct and own the buildings and other improvements on the property. This right allows the tenant to tailor the development to their specific business needs (e.g., a corporate headquarters, a big-box retail store, or a hotel).

• Triple Net Lease Structure: Ground leases are almost always structured as an absolute triple net lease (or similar "net" structure). This means the tenant is responsible for virtually all costs associated with the land and the improvements, including:

  • Base Rent (for the land)

  • Property Taxes

  • Property Insurance

  • Maintenance, Repairs, and Structural Replacements

  • Utilities and other Operating Expenses

• Reversionary Interest: This is the most critical feature. At the expiration or termination of the lease term, ownership of all buildings and improvements constructed by the tenant typically reverts (transfers) to the landowner, often free and clear of all liens. This is the landlord's long-term benefit for the initial lease.

Ground leases offer strategic advantages that make them appealing to both parties:

For the Landlord (Lessor)

• Passive, Long-Term Income: Generates a stable, decades-long, passive income stream with minimal management responsibilities (as the tenant pays all operating expenses).

• Retained Ownership & Appreciation: Retains ownership of the underlying land, which often appreciates, and eventually receives the valuable improvements (reversionary interest).

• Tax Benefits: Can often avoid significant capital gains taxes that would be incurred if the land were sold outright.

For the Tenant (Lessee)

• Lower Upfront Capital: Avoids the massive initial capital outlay required to purchase the land, freeing up funds to invest solely in the construction of the building and business operations.

• Access to Prime Locations: Gains access to desirable, high-traffic land that the landowner may be unwilling to sell (e.g., land owned by non-profits, trusts, or large institutions).

• Tax Deductions: Rent payments and depreciation on the improvements are often tax-deductible business expenses.

The distinction between ground leases is crucial for financing the tenant's construction:

• Subordinated Ground Lease: The landowner agrees to subordinate their fee interest in the land to the tenant's construction lender. This means the lender's mortgage lien takes priority. If the tenant defaults on their construction loan, the lender can foreclose on both the improvements and the land. This makes financing easier and cheaper for the tenant but poses a greater risk to the landowner.

• Unsubordinated Ground Lease: The landowner does not subordinate their interest. Their ownership of the land remains superior to the tenant's mortgage. If the tenant defaults, the lender can only foreclose on the leasehold interest and the improvements, not the land itself. This protects the landowner but makes financing more difficult and expensive for the tenant.

Ground leases are complex contracts that require extensive due diligence and negotiation, particularly around the reversionary clause, rent escalation, and financing provisions, making them a specialized area within commercial real estate law and finance.

For knowledgeable and experienced legal representation in negotiating, reviewing and drafting lease agreements, and protecting your business’ legal rights thereunder, contact lease lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.