Land Lease Agreements 

In a typical homebuying scenario, the buyer purchases both the home and the land that the home sits on. Many purchasers consider the land and the house to be intrinsically linked—however, in some circumstances, buyers only purchase the house and pay rent on the land that the home is on. This type of deal is called a land lease.  

In this article, we’ll discuss what a land lease agreement (also called a ground lease agreement) contains and how they work in real estate investing. We’ll discuss the pros and cons of this arrangement as well as circumstances under which you might choose the alternative route of buying the land along with the property or right to develop. 

What is a Land Lease? 

A land lease (sometimes called a ground lease) is an arrangement in which someone purchases a property but rents the land it sits on, rather than buying both together. During the lease period, the tenant can usually develop the property as they see fit, which must then be turned over to the owner after the lease expires. 

The land is leased for a long period (usually between 50 and 99 years) from an individual or company, who maintains ownership of the land itself. This arrangement creates a more affordable route to homeownership, as homes sold separately from the land are typically priced below market value compared to similar properties nearby. 

Land leases are common for mobile home parks, manufactured housing, and vacation properties, but this setup is also common in the commercial space. Often, leased-land properties can be identified by their setup within a neighborhood: The homes are often built close together and have similar appearances as homes within an HOA sometimes do. 

How is a Land or Ground Lease Created? 

If an investor, developer, or prospective homeowner finds a plot of land they would like to develop, they can reach out to the owner of the land and negotiate a deal. The deal will be formalized as a lease agreement signed by both the developer and the landowner. The lease gives the developer the right to build on that land for a set number of years, after which any land improvements that were made become the property of the landowner. 

While the duration of land leases vary, they typically span at least 50 years. They also spell out who is responsible for any construction issues, property taxes, and other fees (the property owner usually takes on the brunt of these obligations). 

Dynamics of a Land Lease 

Tenants in a land lease agreement will play the role of both homeowner and renter. After purchasing the property (either in cash or financing with a mortgage) and leasing the land, they are responsible for all fees, additional expenses, and HOA dues included in the agreement. They must also either pay a mortgage or cash fees to the owner of the land.  

Fees and Terms 

HOA fees in particular make the dynamics of a land lease much different than other properties. HOA fees for leased-land properties tend to be much higher on average: Rather than paying a few hundred per month, you might be paying up to $900 per month. This is because leased-land properties tend to occur in communities, where fees from each tenant or developer contribute towards maintaining the community’s landscaping and amenities like pools or fitness centers. 

Tenants who aren’t aware of this up front will be surprised to learn about hefty fees when reviewing their lease agreement. Lease terms and conditions, including all included fees (e.g., who is paying property taxes) and the length of the lease term should be communicated and agreed upon before anything is signed. The rights of the landlord and tenant should be discussed as well, and it would be a good idea to have a lawyer present for these discussions and agreements to avoid the potential for future legal issues. 

Types of Land Lease Agreements 

Land leases are common in various communities across the U.S. For instance, trailer parks are the most common type of leased-land community, but leased land can also be found in leasehold condo communities, Native American reservations, or retirement communities. 

There are two primary types of land leases from the financing perspective: Unsubordinated leases and subordinated leases. 

Unsubordinated Land Leases 

Unsubordinated leases, which are more common, keep the land and property separate and grant the landowner priority in land claims. These tend to be pushed more by landlords since they protect their land more than a subordinated lease would. If the tenant defaults on their payment, the land will be protected, and the owner is not at risk of losing their property since the lender cannot foreclose upon the land. However, due to this protection, banks are less eager to offer finance offers to developers seeking an unsubordinated ground lease. 

Subordinated Land Leases 

Subordinated land leases position the property owner lower in claims priority. In a subordinated lease, the landlord agrees that the lender has first claim to the land and will take lower priority in the ownership hierarchy. If the tenant does not pay what they owe for use of the land, the lender has the right to foreclose on the land and sell it to pay off the debt. Anything left over after the debt is repaid will be passed on to whoever is leasing the land. Because the lender has a higher position in a subordinated ground lease than in an unsubordinated lease, it is far easier for developers to get necessary financing with a subordinated lease.  

Surrender Clauses 

A surrender clause is a clause in the land lease agreement that specifies when the lease will expire and what will happen when it does. 

The specific terms of the surrender clause are important. Theoretically, if a land lease expires without renewal, the tenant might face eviction. While this is rare, you might have to give up use of the land and surrender the improvements you made to it and your property.  

For this reason, land or ground leases are sometimes a barrier to traditional equity. There is a risk of losing the equity you’ve built in a home over the years if your lease expires and you lose access to the land your home is built on. It will be more difficult to sell the home over time as the lease shortens. A home on leased land ultimately isn’t as valuable of an asset as a traditional home. 

Commonly, however, a land lease will extend longer than you want to remain in the home or even longer than your remaining lifespan. In this case, you have the option of continuing to live in the property for as long as you want without having to worry about your lease on the land expiring. 

Pros and Cons of Land Leases 

Land leases can be beneficial to both tenants/developers and landlords/owners. Let’s look at the pros first, for both parties: 

Pros 

• Lower property taxes. Tenants in a land lease agreement are only taxed on the property, not the land, lowering their annual tax bills. 
• More affordable route to homeownership. The price of a home can be substantially reduced when the land is excluded from the purchase. Buying a home on leased land can create a more affordable route to homeownership. 
• Better access to hot markets. Because buying a property with a land lease is cheaper, investors (especially commercial ones) can use this type of lease to access prime locations without taking on substantial debt. 
• Time. Construction projects are notorious for delays—when you sign a land/ground lease, typically that agreement lasts anywhere from 50 to 99 years, which is plenty of time for the developer to get their project up and running. For the landowner, they know that they have steady income for the length of the agreement.  
• Amenities. Leased-land communities often have nicer amenities provided by high HOA fees. For instance, tenants living within such a community might have access to swimming pools, fitness centers, golf courses, clubhouses, or regular landscaping/lawn care.  
• For landlords: Landlords can benefit from tax savings by leasing the land rather than selling it. Long-term lease agreements generally have lower tax implications than large land sales. 

Cons 

As is true with any investment, there are also potential downsides. Here are a few: 

• Compounding costs. While developers may be attracted to land leases because they can swap a hefty up-front payment for monthly rent, keep in mind that land leases can last for up to 99 years. The total cost of those monthly payments can end up costing more than it would’ve cost to just buy the property outright. 
• Rent increases. Mobile homeowners in particular might find rising rent troublesome as they lease land. For example, if a new firm takes over a mobile home park, they might increase rent, making the land unaffordable for some tenants. 

• High HOA fees. As mentioned above, high HOA fees drive up the total cost of leased land properties. 
• Less flexibility/Difficulty selling the home. Due to the long terms of most land lease agreements, tenants have less flexibility to exit the agreement, sell their home, and move if costs are too high or other difficulties arise. 
• Ownership issues with improvements. Some land leases state that any improvements a developer completes on the land could become the ownership of the landowner at the conclusion of the lease. If you, the tenant or developer, lose ownership of the development on that land, your possible financial returns are diminished. It’s a good idea to have an attorney look over the terms of the agreement before signing anything. 

Investing in Land:  Floor Area Ratio 

Although land leases exclude land in the purchase of a property, sometimes it is beneficial to purchase land with a traditional mortgage. When is this the case? 

It can be better to purchase a property with land included if it will be cheaper to do so in the long run, if you want more flexibility to sell your property and move, or if you plan on passing down your property to heirs. Traditional homeownership allows you to build equity in your property more safely and avoid monthly fees associated with leasing the land. 

If you do choose to invest in land as well as property, one important factor to consider is floor area ratio. Floor area ratio is the ratio between the total usable floor space a building has and the total area of the land included in the lot. Although local governments do regulate floor area ratios, investors can capitalize on the land they own by increasing the floor area ratio, which allows more space for additional projects. For commercial real estate investors, this often means more sales, lower costs, and more opportunities to expand and build on existing properties. 

Conclusion 

As you consider a land lease for your next real estate venture, remember that it offers unique opportunities and challenges.  

Whether you’re a prospective buyer or simply curious about alternative homeownership models, delving into the intricacies of land leases can help you navigate this aspect of the housing market effectively.