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Lender's Perspective On Financing A Ground Lease

(July 25, 2014)

Though no rigid standards or definitions exist to distinguish a ground lease from a space lease, typically a ground lease is a lease of an entire tract of land that confers on the tenant control over the land that is functionally the equivalent of ownership for a long period of time.  In addition to other indicia of ownership, the ground lease tenant usually has the right to develop the land and sublease it to third parties.  By contrast, under a traditional space lease, the landlord retains more control over the land, and the tenant leases only a portion of the land or space within a building for a relatively short period of time.  Though risks to the landlord and tenant are inherent with any ground lease, a properly drafted ground lease can be advantageous to both the landlord and the tenant.  Benefits to the landlord might include  (a) avoidance of capital gains which would be taxed upon the sale of the property, (b) potential increase in the value of the reversionary interest in the land by the improvement made to the land, without the cost of development and construction, (c) an income stream, much like an annuity, without the burdens of ownership of the land, (d) retention of ownership of land that is likely to appreciate in value, such as oceanfront property, (e) retention of ownership of land that the landlord has a sentimental attachment to and/or a desire to pass to heirs, or (f) an income stream from the land for a landowner lacking legal capacity to transfer the property, such as a trustee of a trust prohibited from transferring the land under the terms of a trust.  Benefits to the tenant might include lower cost of development of the land by avoiding purchase expenses, rent deduction from income, and depreciation of the improvements from income. (For this reason, some ground leases provide that during the term of the lease any improvements on the land are the property of the tenant, allowing the tenant to depreciate the cost of the improvements.  Upon termination of the lease, ownership of the improvements reverts to the landlord.)...

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Diana R. Palecek
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