To Buy or To Lease? The Pros and Cons of Ground Leases

Finding great land in New Jersey is hard. Sometimes, the only way to unlock a prime site is to enter into a long-term ground lease with a landowner who refuses to sell. While this structure can be powerful, it introduces significant complexity to your financing and exit strategy.

The Economics: Why Do It?

The primary benefit of a ground lease is capital efficiency. By leasing the land instead of buying it, you:

1. Reduce Upfront Equity: You don't need to raise millions to purchase the dirt. This boosts your Internal Rate of Return (IRR).
2. Tax Benefits: Ground rent payments are typically fully tax-deductible as an operating expense, whereas land purchase costs are not depreciable.
3. Access Prime Locations: Often, generational owners (families, churches, municipalities) are willing to lease but not sell.

The "Bankability" Challenge

The biggest hurdle is financing. Lenders are wary of ground leases because their collateral is the leasehold interest (the building), not the fee simple interest (the land).

Subordinated vs. Unsubordinated

• Subordinated Ground Lease: The landowner agrees to pledge their land as collateral for your construction loan. If you default, the lender takes the land. Lenders love this. Landowners hate this. It rarely happens.
• Unsubordinated Ground Lease: The landowner does not pledge the land. If you default, the lender takes over your lease but still has to pay rent to the landowner. This is the standard structure.

To finance an unsubordinated ground lease, the lease itself must be "financeable." It needs specific clauses protecting the lender (e.g., right to cure defaults, new lease rights if the original is terminated in bankruptcy).

The "Wasting Asset" Problem

Unlike a fee simple property that you own forever, a leasehold interest is a wasting asset. At the end of the term (usually 99 years), the building reverts to the landowner. This affects valuation, especially in the later years of the lease.