Last week, we discussed the ways in which the U.S. mortgage market is unique, which got us thinking about the real estate market more broadly. So this week, sticking to the theme of real estate, let’s talk about an interesting real estate arrangement that you may not have heard about if you aren’t actively covering the commercial real estate beat: ground leases.
So what exactly is a ground lease?
A ground lease is when a land owner leases their property for a period of time to a tenant in order for the tenant to develop and build on the land. After the lease period ends, all developments and improvements are turned over to the landowner. These arrangements allow property owners to retain ownership of a property while generating income and revenue from the land without assuming responsibility for construction, maintenance, or repairs. Tenants also benefit, as not purchasing the land helps significantly reduce upfront costs, and may allow them access to prime locations that would be difficult to obtain otherwise.
Not surprisingly, in addition to holding on to prime real estate, a property owner may also choose to offer a ground lease to avoid capital gain taxes they would have to pay if they sold the property instead. Similarly, tenants may also have tax incentives to choose a ground lease, as rental payments may be fully deductible, whereas principal payments under a loan would not be.
Ground leases are most common in the commercial space, where lease terms can last as long as 99 years in many states. They are commonly used by franchises where a corporate headquarters will purchase the land and then lease it to franchise owners to construct and use the facility. Other national chains, such as Macy’s and Nordstrom, also have many of their locations under ground leases. The government has also used ground leases for special programs, nonprofits, or to encourage specific types of economic development.
When the lease ends
When a ground lease expires, the land owner has the right to take the property and all improvements on it – leaving the tenant with nothing – or to change the lease terms altogether. Although ground leases are most common in commercial real estate, they have also been used for residential properties, often to make housing more affordable. However, as some recent examples demonstrate, the inevitability of an expiring lease means that affordability is only guaranteed for so long.
Residents of a co-op in New York City are feeling the pressure of an expiring ground lease as the rental payment on their purchased homes is set to increase 450%, pending a ruling on the value of the land. The majority of residents will likely be priced out and lose all equity in their homes – many of which couldn’t even be sold within the last decade as banks stopped issuing mortgages for the property and home values dramatically decreased after the land was sold to a new investor who stated the site offered “unique future potential to construct a luxury retail, hotel and condominium tower.” Some residents feel the price hikes are a way to make that happen.
Many condo owners in Hawaiʻi are also worried about expiring ground leases as they watch the value of their homes decline in real time. In 2022, Hawaii Business Magazine reported that 1 in 8 condos for sale on Oʻahu were under a ground lease, and many of them were listed at affordable prices the region hadn’t seen in a long time. However, those prices wouldn’t really matter for long as one listing stated, “this is a LEASEHOLD condo which you must surrender in July 2027.”
One 70-year-old resident of the NYC co-op summed up the situation succinctly, “Losing the equity is the least of my problems. It’s finding another place that I can afford at this point in my life.”
