A Brief Introduction About a Subordinated Ground Lease
A person who wishes to purchase land, but does not have the fullest capital investment to do so, enter into a long-term lease for 50 to 99 years with the landlord. The lease is compensated by way of monthly rental payments. The landlord transfers only the possession of the land to the lessee, whereas the rightful ownership lies solely with him. The cost of development of land is as costly as the cost of acquiring it. Hence to help the lessee to obtain a construction loan, the lessor offers his land as collateral. In other words, ownership is transferred to the lessee/developer beneficially but not completely.
Who Takes the Subordinated Ground Lease? – People Involved
The parties to a subordinated ground lease are
- Lessor – The owner of the land otherwise called a landlord.
- Lessee – The developer of the land who wishes to construct a property on the land in return for monthly rental payments.
Purpose of the Subordinated Ground Lease – Why Do You Need It?
With the booming real estate market, it becomes tough to acquire land and even tougher to construct a property in it. The financial institutions often require the land or any property as collateral for lending a loan or a financial guarantee at least. With this lease, the developer of the property is relieved from the worry of pledging security for his borrowing. The landowner agrees to transfer the ownership of the land exclusively for borrowed funds. The main purpose of subordinating a normal ground lease contract is to enable the lessee to achieve the fullest benefits of the land during the lease period.
Contents of the Subordinated Ground Lease – Inclusions
The following are broad contents to be included in the lease.
- The details of parties to the lease – name, address and social identification number
- Details and specifications about the land – geographical location, dimensions, adjoining and adjacent lands, photographs, sketches etc.,
- Amount of rent payment each month, time and manner of payment
- Duration of lease
- Permitted use of land
- Subordination clause – Conditions by the lessor in terms of placing a cap on loan and interest rate, additional security or guarantee from the lessee, requiring the lessee to contribute part of the loan amount as equity, etc.
- Accessibility to the land – rights and power to the landlord for accessing the land for specified purposes.
- Insurance, taxes, and maintenance – In most of the contracts, the lessee pays.
- Security deposit
- Severability
- Termination
How to Draft the Subordinated Ground Lease?
The lessee should clearly explain the nature and possible effects of introducing a subordination clause in the agreement. The operational and financial projections of the proposed development in the land shall be presented to the landowner to make informed decisions. The landowner shall consult an expert regarding the risks of undertaking the subordinated ground lease. The lease rent, cost, and timeline of the development, period of the lease, and repayment schedule of the borrowing should be given due consideration before entering into this contract.
Negotiation Strategy
The lessor or the landowner holds an upper hand in negotiation in a subordinated ground lease. Since he provides the title of the land for the benefit of the developer, he is at the advantage of bargaining for higher rent above the market value.
Benefits & Drawbacks of Subordinated Ground Lease
The merits of entering a subordinated ground lease are as follows
- The lessee is at the prime advantage of obtaining a mortgage without any hassles.
- The lessee can channelize his resources towards the core operations of his business. The burden of capital expenditure is spread over several years. He can repay the borrowings in a phased manner once the business break evens.
- The lessor can utilize the idle capacity of land as he supports the development of property which in turn increases the market value of the land. He gets double benefit by way of higher rent and an increase in the market value of the land.
A subordinated ground lease also has certain disadvantages
- A significant drawback of the subordinated ground lease is in case of default by the lessee; the lender has recourse to the land of the lessor. The title to the property is always under stake, and this puts the landlord under sustained pressure.
- The development of property takes a considerable amount of time. The interest on borrowed and lease rent eats the inconsiderable amount of operating cash flow.
What Happens in Case of Violation?
The violation(1) of subordinated ground lease can happen in case of default of lease payments, usage of land beyond the usage restrictions stipulated in the agreement. The lessor may request immediate evacuation of land by the lessee. The damages if any provided in the agreement shall be paid along with the lease rent payable to the landlord.
In case of default of payment of interest and principal installments by the lessee, the lender shall take recourse on the title of the land from the landowner. The subordination clause of the ground lease is given effect in case of default in payments by the lessee.
A subordinated ground lease is a form of contract which extends the benefits of a capital lease. The long-term use of land is best utilized in terms of the development of the property. The subordinated ground lease contract shall explain the rights and ownership of the parties to the agreement during the lease period. The lessee is entitled to use the title of the land only for the borrowed. A normal long-term lease is unsubordinated and adding a subordination clause outspreads the legal nature and benefits derived out of the contract.