It's not news that one of the hottest commodities on the market today is commercial property. Developers and investors in Houston are scrambling to acquire land that is almost guaranteed to increase in value, many retailers and commercial developers are overlooking the advantages of developing and building on property that they don't own.
Municipal ground leases have a long history. It's not unusual for a city or town to lease land to educational institutions, for instance, retaining ownership of the land while giving the lessee the control needed to make improvements to the property. Those leases generally run for terms of 99 years, and often carry nominal lease fees. The advantage to the city is clear - they are home to an institution that adds value to the community, increasing the value of other real estate and making the community a more desirable place to live. The lessee also gains an advantage - they don't need to purchase the land on which they sit.
Terms tend to run for much shorter lengths of time - as short as 5 years, though 30 year terms are common for a ground lease for sale. The advantages of these leases is for the landowner - the landowner retains ownership of the land and ensures a steady income from the rent paid on the property. In addition, ground lease terms often specify that improvements to the property revert to the owner at the end of the lease term. But what advantages are there for the tenant in a ground lease arrangement?
- Frees capital that would be paid for land acquisition
Since there's no need to finance the acquisition of the land, the developer/lessee has more capital available for building and construction.
- Ground lease payments offer a tax advantage
Lease fees can be deducted as a business operating expense on taxes, reducing the tax burden on the lessee. The lease fees will nearly always be a greater deduction than interest paid on a commercial mortgage, and the lessee will not be responsible for tax payments on the land.
- Lessee is protected from downturns in the real estate market
The real estate market is volatile. A lessee's investment in a ground lease commercial property is not dependent on the increasing value of the land. Rather, their retail or commercial activities provide added value.
As with any real estate transaction, there are both pros and cons to taking on a ground lease for sale. Houston residents, a great deal depends on the terms of the lease and its flexibility. It is definitely an option worth considering, however, particularly in an area where outright purchase - as in master planned communities - may not be an option. The opportunity to enter into a long-term ground lease with the owners/developers of a major master planned community can offer the flexibility and benefits needed for a successful retail operation with a ready market of both consumers and employees.
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The Johnson Development Corp. is a Houston-based residential and commercial land development company that has over 40 years of experience in the real estate development business. For more information visit http://www.johnsondevelopment.com