What Is Ground Leases?
A ground lease is a long-term lease of land, typically 49 to 99 years, under which the tenant builds and owns the improvements, pays the landowner a ground rent that escalates over time, and at expiration returns the land and whatever stands on it to the landowner. For the landowner it is a bond-like income stream secured by the tenant's building, senior to every other claim on the property; for the tenant it is a way to control a site without buying it, at the cost of a rent that rises and a reversion that looms.
| Item | Detail |
|---|---|
| Term | Commonly 49 to 99 years, sometimes with extension options |
| Rent | A percentage of land value at inception (3% to 5%), escalating with CPI or fixed steps, often with resets to market every 25 to 50 years |
| Priority | The landowner's interest is senior to the tenant's mortgage; a default returns the land and building |
| Reversion | The improvements revert to the landowner at expiration |
| Uses | Hotels, office towers, retail, apartments on institutionally or family-owned land; ground lease REITs and funds buy the landowner's position |
| Tax | Ground rent is ordinary income; land is not depreciable; the tenant depreciates its building |
How Does Ground Leases Work?
The landowner leases the site to a developer or owner who builds and operates the building and pays ground rent, which starts at a modest yield on the land value and escalates; the tenant finances its building with a leasehold mortgage that is subordinate to the ground lease, so if the tenant defaults the landowner takes back the land with the building on it. Because the ground rent is a small share of the property's income and the landowner's claim is senior, the income is very secure, and because the land plus the reversion of the building is the landowner's upside, ground leases have attracted specialized REITs and funds that buy them as long-duration, inflation-linked, senior real estate income. For the tenant, the rent resets and the reversion make long-term value uncertain, and a lease nearing expiration becomes hard to finance or sell. IRS rules treat ground rent as ordinary income to the landowner and a deductible expense to the tenant; the tenant depreciates its building under Publication 946; Publication 544 covers the sale of either interest.
Worked example. A landowner ground-leases a $20 million site at a 4% yield, $800,000 a year, escalating 2% annually for 99 years. Over the first 30 years the rent totals about $32,454,463, secured ahead of the tenant's mortgage by a building the tenant spent $80 million on. If the tenant defaults in year 20, the landowner takes the building; at the end of the term, the building reverts regardless. The tenant's economics are the mirror image: a rising rent on a building it will eventually hand back, which is why leasehold interests trade at a discount that widens as expiration approaches. The inputs are illustrative numbers, not market data.
What Does Ground Leases Cost?
For the landowner, almost none: no operating costs, no capital expenditure, and legal costs at inception and resets; for the tenant, the ground rent itself, the higher cost of leasehold financing, and the erosion of leasehold value over time; for ground lease REIT investors, management fees.
How Is Ground Leases Taxed?
Ground rent is ordinary income to the landowner, reported on Schedule E or through a REIT, with no depreciation since land does not depreciate; the tenant deducts ground rent as a business expense and depreciates its building under Publication 946; the sale of a leased fee or leasehold interest produces capital gain or loss under Publication 544; section 1031 exchanges apply to both interests.
What Are the Risks of Ground Leases?
- For the landowner: very long duration, so the value falls sharply when interest rates rise; tenant default in a weak market can return a building worth less than expected.
- For the tenant: rent resets to market can jump, financing becomes harder as the term shortens, and the building's value trends to zero at expiration.
- Dispute risk at resets and expiration, with litigation over valuation and improvements.
- Inflation mismatch if escalations are fixed rather than CPI-linked.
Common misconception. A ground lease is not a passive land investment with no downside. The landowner holds a very long-duration bond-like claim whose price moves sharply with rates, and the reversion's value depends on a building the landowner does not control; the tenant holds a depreciating interest in a building on land it does not own, which lenders and buyers discount more each year. Both sides are making a century-long bet on the site.
Where Does Ground Leases Fit?
Liquidity. Moderate for leased-fee interests, which ground lease REITs and institutions buy; poor for leasehold interests with short remaining terms.
Who uses it. Landowners and institutions seeking senior, inflation-linked, long-duration real estate income; developers who want control of sites without the capital to buy them and understand the leasehold's lifecycle; ground lease REITs for investors who want the landowner's position with liquidity.
Portfolio role. For the landowner, a long-duration income holding closer to an inflation-linked bond than to equity real estate; for the tenant, a financing structure whose cost rises over time; in a portfolio, the REIT form is the practical route.