How Long A Ground Lease?

Source: Forbes
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Property owners and developers who negotiate ground leases sometimes disagree on how long the lease should run. Though 99 years is the norm, sometimes the parties try to do something else. But it’s not a difficult issue. If you’re negotiating a ground lease, usually no good reason exists to make the term less than the typical 99 years. And if you can make it longer, you should.

In New York, this discussion often begins when someone points out that if you limit the ground lease term to 49 years, then you avoid transfer taxes. Sometimes that comment is followed by the brilliant idea of still avoiding transfer taxes by having a 49-year term, but giving the tenant options to bring the lease up to 99 years or some other very long duration.

Yes, a ground lease of 49 years or less generally does not incur New York transfer taxes. But transfer taxes shouldn’t guide the decision. There’s more to it.

To start with, if the term starts at 49 years but the tenant has renewal options, then the New York tax collectors will measure the term assuming the tenant will exercise all its renewal options. That’s a pretty good assumption. So the tax collectors are way ahead of the great mind that suggested a 49-year term with renewal options.

Usually when any ground lease – in New York or elsewhere – has renewal options, the main function of those options is just to give the property owner a future windfall if the tenant forgets to exercise or screws it up. Rarely will a tenant decline to exercise any renewal options. So a tenant should try to just have a very long term, 99 years or more, rather than have some option terms and wait for the excitement, disasters, and litigation they often bring.

Really, the tenant should just try to get as long a ground lease term as possible. The problem with ground leases is they end. And before they end, buyers of the leasehold – and lenders who might finance those purchases – and appraisers who help those people decide how much to invest – know ground leases will end. Starting around 20 years before the end of the term, buyers and lenders will worry that the “short” remaining term makes the ground lease not such an attractive investment. And in fact the ground lease is a “wasting” asset, losing value as its remaining term drops. General appreciation of all real estate may counterbalance this, at least in periods when real estate is appreciating, but it doesn’t always appreciate.

In any case, the last 20 years or so of a ground lease is not all that appealing to a tenant/investor or a lender. Lenders will worry that the lease doesn’t have enough term remaining. Buyers will hesitate to invest in a building if their horizon is less than 20 years. Among other things, they won’t want to make major capital expenditures that might have a useful life longer than the lease. Some investors may disagree with the reference to 20 years, and instead say the problems arise earlier or later than that. It’s a matter of taste. In the last few years before the “bad” years begin, the tenant’s position will start to become uncertain and dicey.

Regardless, once the remaining term drops below 10 years, the tenant may find it becomes difficult to sign attractive commercial space leases, technically subleases. That’s because they can’t extend beyond the ground lease term, absent special arrangements with the property owner.

If a tenant agrees to a 49 year term, then the tenant only assures itself of 24 “good” years of lease term (if the tenant believes the “bad” years are the last 20). A 99-year term triples the number of “good” years. A tenant should try to get that or more.