Unsubordinated Ground Lease

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Unsubordinated Ground Lease

A Brief Introduction About the Unsubordinated Ground Lease

Unsubordinated Ground Lease is a type of lease in which the landowner lets his or her land to the tenant instead of selling it outright. Typically, Ground or land leases span over 50-99 years and allow the tenant to build on the land. The lease of the property in such a case is executed via a legal agreement and is generally of two types- subordinated or unsubordinated.

Under the lease, the landowner retains high priority on the property in case the tenant defaults in the repaying the loan taken (if any) for undertaking improvements on the said property or land. In other words, the lease does not allow a lien to be placed on the landowner’s fee simple interest in the land. However, a lien can be secured on the leasehold estate of the tenant as primary security for the loan. While landowners generally prefer the lease, lenders or loan providers may refrain from dealing in lands secured by it and are more in favor of subordinated ground leases.

Who Takes an Unsubordinated Ground Lease? – People Involved

A ground lease is a lease of land between the landlord and tenant, wherein the landlord is different from the owner of improvements on the land (i.e., the tenant). As mentioned above, the lease is usually preferred by Landlords who do not wish to relinquish their claims on the land in case a default is made the tenant in the repayment of any improvement loans.

Similarly, tenants may also prefer this type of lease wherein they benefit from the lower rents and fees under it as against those in case of a subordinated ground lease.

Purpose of an Unsubordinated Ground Lease – Why Do You Need It?

A ground lease separates ownership of land from the ownership of building and improvement on the land and hence can be favorable for both the landlord and tenant in case of massive real estate or construction projects. The purpose of the lease is to provide the owner of the land, the first position in the hierarchy of claims on the asset. Put, it secures the landowner by disallowing the lender to take back the land in case the tenant makes default in repaying the loan taken against it.

Typically, a lease of this type aims at securing the position of the landowner by helping him or her evades the big risk of land acquisition in case of payment defaults made by the tenant.

Contents of an Unsubordinated Ground Lease – Inclusions

Since a Ground Lease amounts to one of the most complex real estate transactions, it should be secured with a water-tight lease agreement and especially so in case of this lease. While drafting the agreement, the owner must specify that he or she will not relinquish any claims on the land in case of payment defaults. Similarly, it should also include a detailed description of mortgages – whether and how the tenant can mortgage his or her leasehold interest in the land for securing loans.

How to Draft an Unsubordinated Ground Lease?

Points to Consider While Preparing the Agreement

The lease should be drafted with utmost precision as it involves a huge interest at stake for both parties to the contract. In addition to the standard clauses, the lease should include terms on liens and encumbrances that describe the tenant’s right to obtain financing, limitations on financing, rights, and liabilities of leasehold mortgage, and so on. Similarly, the lease should only be entered into/ drafted after carefully assessing the tenant’s market position and his capacity to pay off debts and loans against construction.

Negotiation Strategy

Since an unsubordinated lease isn’t easy to draft, it is advisable to involve seasoned real-estate lawyers while preparing the agreement or while negotiating it. It may also be wise to get the lease vetted by a panel of experts as against involving only one lawyer to benefit from the advantage of renewed scrutiny in the transaction.

Benefits and Drawbacks of an Unsubordinated Ground Lease Agreement

The Lease holds both pros and cons for the landowner and the tenant (depending on the nature and inclusions of the lease) as stated below:

Pros :

  • It enables the landowner to stay protected in case of loan repayment defaults by the tenant. Landowner maintains first right on the property and has lender has no lien on his or her fee simple title to the land.
  • Tenant benefits from lower rents as unsubordinated leases are generally priced lower than subordinated ground leases.

Cons:

  • The lease is generally not preferred by lenders, the tenants may, in turn, opt against it. The lease may thus not be optimal for landowners as they can struggle to find the right tenants for the land.
  • In involves competing interests of the landlord, tenant, and the lender and is thus complicated in nature.

What Happens in Case of Violation?

A violation of the lease can be dealt with by the termination and dispute clauses mentioned in the contract. If the violation is minor, i.e., delay in payment of rents, basic construction damages, or maintenance issues, they can be resolved by adhering to the dispute resolution mechanism as agreed upon the lease agreement. In case of bigger defaults, either party to the lease can file for termination(1) as well as for damages depending upon the nature of the violation and terms of the agreement.

An unsubordinated ground lease is a type of land lease wherein the landlord maintains the first right on the property in case the tenant defaults in paying the loan amount that he or she has secured for making improvements on the land. The lease transaction includes competing interests of the landlord, the tenant, and the lender and hence should be supported by a well-drafted lease agreement.