Net lease real estate remains a compelling option for investors seeking stable, long-term income with a conservative risk profile. Beyond single-tenant and multi-tenant net lease properties, another strategy to diversify returns is investing in ground leases.
A ground lease—sometimes called a land lease—allows investors to retain ownership of the land while generating predictable income from tenants who develop and operate improvements on the property. Before adding a ground lease to your portfolio, it is important to understand both the potential advantages and the unique responsibilities that come with being the landowner. When structured properly, ground leases can offer durable, inflation-protected returns, but careful due diligence is essential to maximize long-term value.
What is a Ground Lease?
As the name implies, a ground lease involves leasing only the land, not any existing buildings. In this structure, the tenant rents underdeveloped land with the right to construct improvements, which they own during the lease term. The landowner retains ownership of the land itself while granting the tenant operational control of the improvements. Effectively, a ground lease is a long-term agreement in which the tenant assumes responsibility for developing, financing, and maintaining the property improvements, while the landowner provides the underlying land.
In most cases, the tenant covers construction, operating, and maintenance costs, while the landowner remains responsible for property taxes on the land. Ground leases—particularly NNN ground leases—are often structured as very long-term commitments, typically 20 to 40 years initially, and in some cases extending 50 to 99 years. If the tenant defaults or the lease expires, ownership of the building and any improvements reverts to the landowner, or the tenant may be obligated to remove them.
How Ground Leases Work in Commercial Real Estate
In a standard ground lease arrangement:
- The tenant pays scheduled rent to the landowner in exchange for the right to use the land.
- The tenant finances, constructs, and owns improvements—such as buildings or parking structures—throughout the lease term.
- Responsibility for most operating expenses, including maintenance, insurance, and property taxes on the improvements, typically falls to the tenant.
- A reversion clause ensures that, upon lease expiration, ownership of all improvements transfers to the landowner.
This structure allows landowners to generate income from underutilized parcels while maintaining long-term ownership and control of their assets.
An Example of a Ground Lease
During the term of a ground lease, the tenant owns any improvements made to the property, including buildings and supporting structures. For example, many Macy’s department stores operate under ground leases—Macy’s owns the buildings and parking structures, but pays rent on the underlying land.
Another prominent example is American Tower, which owns and operates communications towers across the U.S. but typically leases the land beneath them. Approximately 70% of American Tower’s domestic sites are subject to ground leases, involving more than 35,000 property owners nationwide. While the average remaining lease term is about 28 years, the company often extends leases or purchases the land outright rather than allowing agreements to expire.
This structure benefits both parties: American Tower can expand its network without the upfront capital required to buy land, while landlords secure long-term rental income. Additional advantages include potential tax efficiencies, as lease buyouts may shift expenses from operating costs to capital expenditures. For landlords, the arrangement can deliver steady income over decades and, in some cases, culminate in a significant lump-sum payment when the land is sold.
Like other commercial real estate leases, ground leases require tenants to pay monthly rent. They are most often structured as net leases, obligating tenants to cover property taxes, insurance, and maintenance during the lease term.
Common Use Cases for Ground Leases
Ground leases are commonly used in several sectors of commercial real estate:
- Urban Retail Development: National brands such as Walgreens, McDonald’s, and Starbucks frequently rely on ground leases for freestanding or drive-thru locations.
- Telecommunications Infrastructure: Companies like American Tower lease small parcels to support cell towers and related facilities.
- Government and Institutional Land: Universities and municipalities may lease land to private developers for student housing, mixed-use projects, or retail.
- Hospitality: Hotels often lease land in high-demand tourist areas to reduce upfront land acquisition costs and preserve capital for development.
Subordinated Ground Lease vs. Unsubordinated Ground Lease
There are two primary types of ground leases: subordinated and unsubordinated.
Subordinated Ground Lease
In a subordinated ground lease, the tenant may finance property improvements by securing debt—often structured as improvement-based net lease financing—that uses the land as collateral. Because this structure places the landowner behind the lender in the event of default, it carries greater risk for the landlord. To offset this risk, landlords typically charge higher rent payments under subordinated leases.
Unsubordinated Ground Lease
In an unsubordinated ground lease, the landowner maintains priority on claims to the land if the tenant defaults. Lenders cannot seize the land, which makes this structure less attractive to many financing institutions. As a result, landlords often charge lower rent under unsubordinated leases to incentivize tenants to sign. While unsubordinated leases may generate less income, they are more common because landlords prefer to protect ownership and reduce exposure to tenant financial risk.
Advantages of a Ground Lease for Landowners
Ground leases can provide several long-term benefits for landowners:
- Stable, Long-Term Income: Rental payments often extend for decades, offering consistent and predictable cash flow.
- Low-Touch Management: Tenants are responsible for development, operations, and ongoing maintenance.
- Property Appreciation: Land values may increase as tenant improvements enhance the surrounding area.
- Future Ownership of Improvements: At lease end, buildings and other improvements typically revert to the landowner.
This model is especially appealing for landowners in prime locations who want to generate income without selling their property. Ground leases also provide strategic flexibility, enabling landowners to preserve generational wealth while benefiting from commercial development. Family offices and trusts often prefer ground leases for this reason, as they ensure land remains in the family for decades.
Many ground lease transactions involve highly sought-after parcels with unique attributes that cannot be replicated. In such cases, landowners can profit from leasing the land to developers without selling or undertaking costly site improvements themselves. If the landowner controls nearby parcels, those properties may also increase in value as new development occurs.
Major corporations such as McDonald’s frequently use ground leases to expand their presence. McDonald’s often acquires the land and then leases it to franchisees, who finance and construct the restaurant. This structure ensures the property is dedicated to McDonald’s operations, preventing a franchisee from later converting the site to a competing brand.
Most triple net (NNN) ground lease agreements also include a reversionary clause. This clause stipulates that if a tenant defaults or the lease term expires, ownership of the building reverts to the landowner—typically at no additional cost. The provision protects the landowner’s investment and secures future income potential from both the land and improvements.
Advantages for the Tenant
Tenants benefit from ground leases in several important ways:
- Access to Valuable Land: Tenants can secure prime locations without the high upfront cost of purchasing property. In a triple net (NNN) ground lease, this often means access to sites that would otherwise be unavailable without significant capital.
- Equity in Improvements: Tenants own the buildings and improvements they construct during the lease term.
- Tax Advantages: Lease payments and building depreciation may be tax-deductible, allowing tenants to reduce taxable income.
- Development in High-Barrier Markets: Ground leases provide opportunities to build in areas that are otherwise cost-prohibitive, such as government-owned or institutionally held land.
For example, in certain cases, government properties may be too expensive to purchase outright, but can be leased for development at a fraction of the cost. Ground leases also allow tenants to expand business operations without the capital intensity of land acquisition. This structure is particularly attractive for franchisees and operators scaling across multiple markets.
Drawbacks of a Ground Lease
While triple net (NNN) ground leases can be highly attractive for investors, there are several important tax and financial considerations to evaluate.
Key challenges include:
- Landowner Tax Limitations: Land cannot be depreciated, which restricts long-term tax benefits.
- Tenant Uncertainty: Tenants do not own the land, creating potential long-term risks.
- Financing Challenges: Some lenders remain hesitant to finance ground lease developments.
- Rent Escalations: Lease terms may include periodic increases tied to land value or market conditions.
For landowners, annual property taxes on the land remain their responsibility under a triple net (NNN) structure. Because land does not depreciate, the landowner cannot claim depreciation benefits over time—even though the tenant may depreciate the improvements. This division of ownership between land and improvements limits the investor’s tax advantages.
For a detailed overview of the benefits and drawbacks, see our resource: The Pros & Cons of a Ground Lease | SIG.
The Difference Between a Ground Lease and a Leasehold
The term “leasehold” is sometimes used interchangeably with “ground lease,” though the two can have distinct meanings. In the U.S., residential leaseholds are relatively uncommon, except in specific markets such as Hawaii, the Baltimore metro area, and parts of Florida. Leaseholds are far more prevalent in commercial real estate.
A ground lease generally allows tenants to develop the property as they see fit, with ownership of improvements retained for the duration of the lease term. By contrast, leaseholds may impose more restrictions on the types of developments permitted on the property.
Regional variations further shape how the terms are applied. For example, in Maryland, residential leaseholds are known as “ground rent” and tracked through an online registry maintained by the Department of Assessments and Taxation. If the rightful landowner cannot be identified, lessees may escrow ground rent payments for up to three years until ownership is established.
Under leasehold ownership, the lessee has exclusive use of a property for a specified term but does not own the land beneath it. The leaseholder pays rent to the landowner while holding ownership rights to the buildings and improvements. Improvements made under a leasehold can typically be depreciated for tax purposes, providing a financial advantage to the lessee. At the end of the lease term, ownership of the land and improvements reverts to the landowner.
Lease rents may also be subject to periodic adjustments—commonly every 10 to 15 years—based on current land market value. When land values rise, lease payments typically increase accordingly.
What Happens at the End of a Ground Lease?
During the term of a ground lease, the tenant typically owns and depreciates the improvements they construct. At the end of the lease, ownership of all improvements and additions generally transfers to the landowner under the lease agreement. These provisions ensure that the landowner ultimately holds title not only to the underlying land but also to the tenant’s improvements. However, landlords may also assume certain risks—such as potential environmental liabilities stemming from tenant construction.
In some cases, landlords may be entitled to a termination fee if a tenant elects to end the lease before its expiration. Tenants may choose early termination for several reasons, including a real estate market downturn or broader economic conditions that make development unprofitable.
Frequently Asked Questions About Ground Leases
What is a ground lease in commercial real estate?
A ground lease is a long-term agreement in which tenants lease land, construct improvements, and operate businesses, while the landowner retains ownership of the underlying land.
Do tenants own buildings on a ground lease?
Yes. Tenants typically own the improvements they construct for the duration of the lease term.
Can a ground lease be sold?
Yes. Both the land and the leasehold interest may be sold, either together or as separate transactions.
What happens when a ground lease expires?
Unless otherwise specified, the landowner gains ownership of all improvements at the end of the lease.
Are ground leases safe investments?
When properly structured, ground leases are often considered low-risk investments that can deliver strong risk-adjusted returns.
Can ground leases be used for residential projects?
Yes. In certain high-demand markets, such as Hawaii, ground leases are commonly used for residential development.
What are common rent escalation terms in ground leases?
Rent adjustments may be tied to the Consumer Price Index (CPI), fixed annual percentages, or periodic appraisals of land value.
Is ground lease income taxable?
Yes. Lease income is taxable, though certain structures may allow capital gains treatment if a lease is bought out.
Can tenants refinance buildings on ground lease land?
Yes. This is most common in subordinated ground lease structures, where lenders are granted collateral rights.
What is a reversion clause?
A reversion clause specifies that all improvements on the land transfer to the landowner at the end of the lease term.
Why Work with Sands Investment Group (SIG)?
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