Ground Lease Fundamentals in Commercial Real Estate

Ground leases are an important component of many commercial real estate deal structures. Yet for a lot commercial real estate professionals ground leases are rarely encountered and are poorly understood. In this article we’ll shed some light on how ground leases work, explain what typical ground lease structures look like, and we’ll also clear up some common misconceptions about the ground lease.

What is a Ground Lease?

First of all, what exactly is a ground lease? Ground leases, often called land leases, are simply a lease of the land only. Usually land is leased for a relatively long period of time (50-99 years) to a tenant that constructs a building on the property. A ground lease separates ownership of the land from ownership of the building and improvements constructed on the land.

Why Ground Leases Make Sense

Although it might seem odd at first for a developer or tenant to construct a building on land that is owned by someone else, there are good reasons why a ground lease is advantageous to all parties involved.

Perhaps the biggest advantage for tenants is that a ground lease provides access to well-located land that otherwise could not be bought. This is why ground leases are widely used by many big retail tenants such as McDonald’s, Chick-fil-a, and Starbucks. Another advantage of a ground lease is that the tenant does not have to come up with the upfront cash required to purchase the land in a deal. This lowers the upfront equity required in an investment, freeing up cash for other uses, and also improving the yield.

For the landowner, a ground lease provides a stable income stream typically from a creditworthy tenant, while still allowing the landlord to retain ownership of land. Usually ground leases have built in escalation clauses and eviction rights, which give the land owner adequate rent increases over the term of the lease as well further downside protection in the event of a default. Another benefit to land owners is that ground leases normally have a reversionary clause, which transfers ownership of the improvements to the landlord at the end of the lease.

Subordinated vs Unsubordinated Ground Leases

Subordination refers to the priority of claims or ownership interest in an asset. When a construction loan or a permanent loan is used to finance improvements, the senior lender will require a “first position” in the hierarchy of claims on the asset, which is collateral for the loan. As such, a senior or “first” lender, will require any other lenders or claims on the real estate to be subordinated to it’s first interest.

A subordinated ground lease is simply a ground lease where the landowner agrees to take a lower priority in the hierarchy of claims on the ownership of the land. Essentially, the landowner is pledging the land as collateral for the loan on the improvements, effectively becoming a second or junior lender on the project.

Why would an owner subordinate its interest in a ground lease? There are many reasons why this might be beneficial. One case in particular would be when it facilitates debt financing to construct a building that will add value to adjacent properties also owned by the owner of the ground lease. This would provide the landowner with additional benefits outside of the subject transaction. Another reason is that the land owner could in exchange negotiate higher lease payments or otherwise more favorable terms.

On the other hand, an unsubordinated ground lease is a ground lease where the landowner maintains its first position in the hierarchy of claims on the asset. In this case, a lender would not have the right to take back the land in the case of a default by the tenant. This unsuborninated position is considered much safer for the landowner (superior even to the mortgage) and as such this usually comes with a lower lease rate. Under an unsubordinated ground lease lenders will be more reluctant to lend, but will usually just take into account the lease payments during loan underwriting when determining the maximum loan amount on the property.

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Ground Lease Valuation

Ground lease valuation is not unlike the valuation of any other lease or cash flow stream. Since there is a clearly defined lease term, lease rate, escalation schedule, and terminal value, a projection of these cash flows can be created and then discounted to determine a present value.

The selection of the discount rate would largely depend on how risky these future cash flows are. The risk profile of a ground lease is influenced by subordination, credit quality of the tenant, future attractiveness of the location, quality and value of the improvements, and any other relevant terms of the lease. As with all leases, it’s always important to thoroughly read the lease to gain a complete understanding of who is responsible for what and when. These lease terms can then be used to complete a discounted cash flow analysis.


Ground leases are an important component of many commercial real estate transactions. A ground lease typically comes with a very low yield due to it’s rock solid income stream. However, the income stream from a ground lease is considered very safe, especially when unsubordinated and therefore superior to even the mortgage. While there is often times a strong preference to own rather than rent, ground leases can provide attractive benefits to developers and tenants, without transferring ownership of the land.

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  • Zooom

    so can a land be leased to a bank for $100k a month

    • Rob

      Please re-state your question and be more specific. In general vague questions produce vague answers. Can you be more specific?

  • Bill

    How would you calculate the monthly land lease payment on a prospective 1.33 acrea property in a retail commercial location that’s valued at just over $1,000,000?

    • DWADE

      I am interesting in knowing this as well.

  • Inutu

    This was an insightful article.

  • Donna smith

    Hello im not sure how this works but i have land in bel air California what is the smartest and safest way to lease my land?

    • This_is_Serious

      Hi Donna,

      I work in the Real Estate Industry in LA. I am very familiar with Bel Air and would be happy to further discuss your land with you.

    • AC

      Test the demand in the market, and see what responses you receive from prospects. More importantly, look around near where your land is, Donna (the market will do the same). What do nearby residents complain about? Grocery too far from gated communities? Too few retail centers within walking distance? Usually the solution to maximizing value for your property lies nearby, since people create value.

      Hope this helps.

      Aaron Cha
      BaIles & Associates, Inc.

  • Kristy

    What would happen if the person purchasing a home through the bank, remained current on their mortgage payments but defaulted on their land lease payments the house sat on? Would the land owners ever have legal rights to the house?
    Also… since the land owners have the ability to go up on the the lease payments, can the monthly lease amount be included in the monthly mortgage payments or will they always be separate?

  • Alex Worden

    I heard this evening that a businessman wants to lease 5 acres of unused land from our HOA for 20 years to plant a vineyard. The land is worth ~3 Million dollars by my estimation. How should we calculate his annual lease. Would the lease rate increase over the 20 year period or would it typically be locked-in?

    • AC

      Rule of thumb: initial ground lease rate = 8% of property’s fair market value at the time of transaction. Terms/conditions of the ground lease, however, depend entitely on what you and your broker/advisor/association negotiate with the businessman, which, when only considering the escalation factor, could result in fixed annual increases, periodic step ups, or even CPI-based adjustable rates. Discounted cash flow method and IRR analysis of 20 yrs of cash flows could provide insights. Again, many variables come into play. We could discuss more if you’d like.

      Aaron Cha
      BaIles & Associates, Inc.

  • Brandon

    Good afternoon! I don’t know if this discussion is still active, but I am hoping for some advice on a ground lease. Ground is 3/4 of an acre 1/2 mile away from Disneyland and is zoned for hotel construction. The immediate reason for needing the land is because I have a hotel/restaurant directly across from Disneyland (much closer than this location) and I need extra parking on a regular basis. Since I just completed a monster reconstruction project on this hotel and carrying a large note, I am not in a position to do another project at least for 4-5 years. They are ok with escalation of lease based on this scenario, as long as I lock in a large term. I am simply trying to figure out what kind of discount I should get for the land until I am ready to move forward with construction. We are talking about a 20 year lease, but I would like a longer one. Value of this land is estimated at $4 mil. Thanks, BG