Enter to open, tab to navigate, enter to select
Ground Leasing Toolkit (CA)
Practical Law Toolkit w-017-8961 (Approx. 8 pages)
Resources to assist landlords, tenants, and lenders in understanding and effectively drafting and negotiating ground leases and related documents in California. This Toolkit includes links to commonly used forms, such as ground leases, memoranda, and estoppels. These resources provide analyses of common ground leasing concerns, including tenant rights, landlord remedies, rent determination, and financing.
A ground lease is typically a long-term lease of land. The leased land may be either:
- Unimproved land where the tenant (also called a ground tenant) constructs new improvements.
- Previously developed property with existing improvements, such as buildings and roads.
Ground lease terms customarily run from 25 to 99 years and are generally at least 20 years. California statutes limit the maximum term of certain leases (for example, agricultural leases, leases of municipality-owned land, and leases of tidelands and submerged land) (Cal. Civ. Code §§ 717 to 719).
The landlord (also called a ground lessor) continues to hold the fee simple ownership interest in the land. The tenant:
- Leases the land from the landlord.
- During the term of the ground lease:
- owns the improvements; and
- pays all expenses attributable to the land and the improvements.
A tenant may gain several advantages by entering into a ground lease rather than purchasing the fee interest in the land, including the ability to:
- Substantially reduce front-end development costs because a ground lease eliminates land acquisition expenses.
- Free up equity while operating at the location (if the tenant owns the real property and sells the land to a new owner).
- Deduct rental payments from federal and state income taxes.
- Get all depreciation benefits for federal and state income tax purposes.
- Use the ground lease as an alternative financing device to acquire a long-term interest in, and right to improve, the land.
There are also disadvantages to a tenant in a ground lease transaction, including that:
- The total long-term costs for ground leasing are usually higher than if the tenant purchases the property.
- The tenant often has less flexibility in the property's development, use, and operation because of ground lease restrictions.
- The tenant may have difficulty financing or refinancing the ground lease because of limitations in the ground lease and because the primary financing is leasehold improvement financing. 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 decrease as the end of the lease term nears.
The landlord may gain several advantages by entering into a ground lease rather than selling the property, such as:
- Retaining the fee ownership in the land and taking ownership of the improvements when the lease expires.
- Enjoying a lower risk for developing the land because the tenant undertakes responsibility for the construction of the improvements.
- Receiving a steady rental income over a long term without incurring management costs.
- Avoiding a sale that may generate a substantial taxable gain to the landlord.
- Allowing the landlord to keep the land in its family for generations.
- Avoiding land sale restrictions if the landlord is a governmental entity or a trust.
- Retaining control over the development and permitted uses of the land.
There are also disadvantages to a landlord in a ground lease transaction, such as:
- Having little or no control over the development and use of the land.
- Not being able to borrow against the fee interest in the land during the ground lease term because the ground lease prohibits it.
- Potentially losing its property during foreclosure or having to satisfy the tenant's loan obligation if the lease allows the tenant to secure its financing with the fee interest in the land, and the tenant defaults under its financing.
- Receiving rent taxed as ordinary income (typically less favorable than the capital gains tax rate on sales proceeds).
- Not receiving a large cash payment like it would from a sale.
- Potentially being liable:
- to governmental entities if the tenant violates applicable laws; and
- to third parties for hazardous substances the tenant releases during the term.
A ground tenant usually needs financing to help fund its development costs and typically gets a construction loan for the construction phase of the development. After the ground tenant completes construction, it gets take-out financing from a term lender to pay off the construction loan. Lenders of the construction loan and the permanent take-out loan want assurances that the ground lease contains clauses that protect the lenders' interests.
This Toolkit contains continuously maintained Practice Notes, Standard Documents, Standard Clauses, and State Q&As to help counsel for landlords, tenants, and lenders manage the process of drafting and negotiating ground leases and related documents in California. In addition to the California-specific resources and guidance, this Toolkit also includes several jurisdictionally neutral ground leasing resources. These resources include forms and discuss issues that are useful and relevant to landlords, tenants, and lenders in every state, including California. For a jurisdictionally neutral Toolkit on ground leases, see Ground Leasing Toolkit (National and Select States).