When you venture into the realm of real estate, one of the most critical decisions you need to make is your choice of lease structure. Two worthy contenders that often come into play are ground leases vs. build-to-suit leases.
Ground leases are better if you want your tenant to be responsible for developments and avoid the high upfront costs and construction responsibilities. Built to suit leases allow landlords more control over the property’s design, layout, and functionality but are more expensive.
It is imperative to compare ground lease vs. build to suit to find which structure aligns best with your specific needs and objectives. To clear the air on which you should choose, we’ll look at the definitions, advantages, and disadvantages of both.
Ground Lease vs. Build To Suit Leases
Choosing the right lease structure isn’t the simplest of tasks because each has characteristics and drawbacks that could make or break your real estate’s success. As a landlord, you have many types of lease structure agreements at your dispense. Comparing ground lease vs. build to suit narrows your options.
What Is A Ground Lease?
A ground lease, also known as a land lease, is a real estate arrangement in which you, the landlord, leases land to a tenant for an extended period, usually a few decades. Your tenant is allowed to develop the land. Also, you retain ownership of the land and all improvements while granting your tenant various rights and privileges.
Lease Term
The typical ground lease agreement lasts between 50 and 99 years. This extended duration provides stability for you and your tenants to make investments in the property.
Rent Payments
Your tenant is to pay either annually, semi-annually, or quarterly. The rent amount is usually fixed, but you can also set the contract to allow adjustments based on specific terms. Terms can save you on inflation or your property’s appraised value.
Development And Maintenance
Your tenant has the right to improve the leased land. They may add buildings, structures, or other developments, but it depends on the terms you set in your lease agreement. Any improvements made by your lessee generally become their property during the lease term.
The fate of improvements after the lease ends depends on what you have negotiated. You need to agree on how the improvements will be treated at the end of the lease. You might need to compensate the lessee for their investments in the property or allow them to remove and sell them.
You’ll also want to consider maintenance and taxes. Depending on your lease terms, you can hold your tenant responsible for maintaining the property and paying property taxes, insurance, and other operating expenses.
What Is A Built To Suit Lease?
In build to suit (BTS) lease, the property owner builds a structure on the land according to the tenant’s needs and specifications. In this arrangement, the tenant plays a substantial role in the design and layout of the property to ensure it aligns perfectly with their business requirements. You then lease the customized property to the tenant.
The types of built to suit lease agreements include:
- Developer agreement: a business partner with a commercial real estate broker to find a developer to finance and construct a customized property.
- Reverse build-to-suit: the lessee designs and builds the building and hires a developer to fund the construction. This option is popular in large chain businesses.
- Sale-leaseback agreement: the business funds the land acquisition and the building. They then find an investor to buy the property and lease it back.
Lease Term
BTS leases often come with longer lease terms, ranging from 10 to 20 years or more. This extended commitment allows your tenants to reimburse their investment in the customized property over an extended period.
Although the property is constructed to meet the tenant’s specific needs, the ownership and the improvements usually remain under your ownership throughout the lease. You could also structure your BTS lease agreement to allow the tenant to acquire your property at the end of the lease term.
Rent Payments
The tenant pays rent to you for the use of the customized property. The rent structure may include intermittent adjustments based on things such as inflation or market conditions. The timing of rent payments in a BTS lease depends on the terms negotiated between you and the tenant.
Development And Maintenance
You, as the developer, typically finance the land acquisition and construction costs, but the tenant plays an active role in overseeing the construction process.
Maintenance responsibilities should be clearly defined in your lease agreement. In some cases, you may retain responsibility for property maintenance, while in others, your tenant may take it on. You’ll also need to outline who is responsible for operating expenses, such as insurance and property taxes.
Advantages And Disadvantages Of Ground Lease
Ground leases place the responsibility of customized buildings into your tenant’s hands, relieving you of some responsibility and a whole lot of costs. These are the pros and cons if you choose this option.
Advantages of a ground lease:
- Ground leases provide a consistent rental income stream over a long lease term.
- You retain ownership of the land, which can be appreciated over time.
- Typically, your tenant is responsible for property taxes, insurance, and maintenance in a ground lease, reducing your operational costs.
- It offers you the flexibility to use the land for other purposes, redevelop it, or quickly lease it to different tenants at the end of the lease term.
- Ground leases usually require your tenant to finance improvements, saving you from the substantial costs associated with construction in a BTS lease.
Disadvantages of a ground lease:
- You have limited control over the design and quality of your tenant’s improvements.
- The fixed rental income cannot increase as much as it could in a BTS lease.
- You do not benefit from the appreciation of your tenant’s improvements.
- You often give up the rights to make your own property developments during the lease term.
Advantages And Disadvantages Of Built To Suit
BTS leases are a lot more costly to you, but this type of agreement definitely has its perks compared to ground leases.
Advantages of BTS leases:
- You have a higher degree of control over the design, construction, and quality of the land’s improvements.
- Unlike ground leases, you benefit from the added value of the improvements.
- BTS lease agreements often allow you to increase rental income substantially over the lease term.
- BTS leases may provide a higher return on investment (ROI).
- Negotiating the terms of a BTS lease can be less complex than a ground lease.
Disadvantages of BTS leases:
- You’ll likely need to invest more upfront capital in acquiring the land and funding the construction.
- If the construction project encounters delays, cost overruns, or other issues, you take on the responsibility.
- Coordinating with contractors and the tenant’s specifications can be complex and time-consuming.
- You have more operational responsibilities, including property management.
- You may have less flexibility in land use for future tenants.
Final Thoughts On Choosing The Right Lease Structure
If you’re looking to choose a lease agreement that allows tenants to make improvements or customize constructions, then ground and build-to-suit lease agreements are your best bet. Ground leases are better if you have less capital and prefer your tenants to take control. BTS leases are more costly, but you have more control and benefit from the appreciation of the construction.