How To Structure A Ground Lease

Ground leases have been used in the UK for hundreds of years, and were originally developed for what were referred to as ‘Landed Estates’. The lease involves a landowner granting a long-term lease on a portion of land to someone so they can construct a building on it. In exchange for granting this lease, the landowner then receives a steady long-term income flow in the form of a ground rent. The majority of ground leases in the UK run for 125 years or longer. When the lease comes to an end, the land and any building constructed on it normally reverts to the freeholder. However, it should be noted that in many instances the leaseholder will have a right to negotiate an extension. In this article, how to structure a ground lease, we take a look at the mechanism and process involved.

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What is ground rent?

Ground rent is a percentage, usually between 5–10%, of the income from the land and buildings. This Ground Rent income is normally increased on a periodic basis (traditionally every five to 21 years) in line with the market rental levels for the land and buildings. If market rental levels have fallen, the Ground Rent usually will stay the same and not decrease. More recently new Ground Leases have Ground Rent increases every one to five years and are often based on the retail price index.

What happens at the end of a lease?

In the UK, when the lease comes to an end, the owner of the land will usually take possession of the land and anything that has been built on it. This is commonly achieved via a reversionary clause within the lease, which transfers ownership of everything back to the owner.

What are the advantages of ground leases for property developers?

There are two main advantages of the ground lease model for property developers:

• Acquiring land via a ground lease significantly reduces the initial ‘up-front’ capital required to fund a project
• In certain circumstances, ground rent payments may be able to be offset against other income for taxation purposes

In most cases, a ground lease offers as much security as the freehold ownership of land. Consequently, a leaseholder can normally pass on their home to their families in their Will, they can sell their home to others in the usual way, they can get a mortgage and they can usually apply for an extension of the lease. Mortgage availability can depend upon the length of the lease term remaining. Lenders will have different approaches to the length of the lease they are comfortable on lending against.

What are the key features of ground leases for developers and purchasers of ground leases?

Ground Leases can offer protection against both tenant default and falling rental values.

Protection from tenant default

The Ground Rent is usually 5-10% of the total income received from the land and buildings. If the Long Leaseholder does not pay the Ground Rent, the Freeholder can potentially terminate the Ground Lease (this is known as “Forfeiture”) whilst leaving the buildings’ occupiers unaffected and thus receive 100% of the income from the land and buildings.

Protection from Falling rental values

Ground Leases are protected against most falling market rental values. This is because the Ground Rent usually represents a small percentage of the total rent from the land and buildings.

Security of capital

Ground Lease capital values represent a small proportion of the Long Leasehold capital value, reflecting the respective size of their income streams. However, unlike a default on the payment of interest on corporate debt, which might lead to a possible total loss of capital, a default by a Long Leaseholder in the payment of the Ground Rent could lead to the Freeholder receiving significant capital windfall. This is because default by the Long Leaseholder will lead to Forfeiture.

What are the advantages to a land owner of creating a ground lease as opposed to selling the freehold?

• The landlord retains the fee ownership and a reversionary interest in the property.
• A ground lease provides the landlord with a low-risk development of the land that results in steady rental income to the landlord over the long term.
• The landlord avoids a sale that may generate a substantial taxable gain to the landlord.
• A ground lease allows the landlord to keep the land in the family for generations.
• A carefully drafted ground lease allows the landlord to keep control over the development and permitted uses of the land.

What are the disadvantages for a tenant in a ground lease transaction?

• The total costs for ground leasing property are usually higher in the long term than if the tenant purchases the property outright.
• The tenant often has less flexibility over the development, use, and operation of the property because of restrictions contained in the ground lease.
• The tenant may have difficulty financing or refinancing the ground lease because of limitations contained in the ground lease. This prevents the tenant from taking equity out of the project.
• The tenant’s leasehold interest under the ground lease is a diminishing asset because the value and marketability of the project diminishes as the end of the lease term nears.

How We Can Help

Our team is well versed in dealing with all the various aspects of creating and advising upon ground leases and we are here to help in any way we can. We are able to explain clearly the legal issues and provide open, honest and professional advice.

How to Contact our Commercial Property Solicitors

It is important for you to be well informed about the issues and obstacles you are facing. However, expert legal support is crucial in terms of reducing risk, saving you money and ensuring you achieve a positive outcome.

To speak to our Commercial Property solicitors today, simply call us on 0345 901 0445, or allow a member of the team to get back to you by filling in our online enquiry form. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.

Authored by Ben Posted in Commercial Property, News Tagged as