Ground leases are generally long-term leases of property entered into between a property owner and tenant where the tenant leases land and subsequently constructs a building or other improvements on that land. Since ground tenants do not own fee title to ground leased property, financing to acquire a ground lease or construct improvements on ground leased property is more complex that conventional mortgage financing.
A leasehold lender’s primary collateral is the ground lease itself, as opposed to the underlying land and improvements. Like a fee mortgage, if a ground lease tenant defaults on its financing, its leasehold lender will have to foreclose. However, the interest being sold at the foreclosure sale will be a ground lease and the rights thereunder as opposed to a fee interest in the land. This makes the marketability (also referred to as “financeability”) of a ground lease critically important to tenants and leasehold lenders.
There are several critical elements which must be incorporated into a ground lease in order for the ground lease to be considered “financeable” by a leasehold lender. A few of these key elements are discussed below:
Lengthy Term: Although different leasehold lenders have different requirements for the length of a ground lease, in order to be financeable, the term of a ground lease must extend well beyond the maturity date of the leasehold financing to ensure that there is enough time to amortize the loan, refinance the loan or sell the ground lease to a new tenant in the case of a foreclosure.
Broad Permitted Use: The permitted use in a ground lease should be as broad as possible so that the leasehold lender has options and a large potential purchase base.
No Limitations on Leasehold Mortgaging/Assignment/Subletting: Not only does the ground lease need to provide that the leasehold interest can be mortgaged to a leasehold lender without consent, the leasehold lender will want to ensure that it can freely foreclose on the property and further assign the lease or sublet the property without the need to get the fee owner’s consent or other restrictions.
Leasehold Lender Right to Cure Defaults: The leasehold lender will want the right to cure a default on behalf of the tenant under the ground lease in order to protect its collateral and prevent the landlord from terminating the ground lease. Generally, the leasehold lender will want its cure period to extend beyond the cure period provided to the tenant. Moreover, the leasehold lender will want the landlord to have obligations to enter into a new ground lease with the leasehold lender on the same terms as the existing ground lease in the event the ground lease is terminated due to bankruptcy, default or for any other reason.
No Amendments without Consent: Neither the landlord nor the tenant should have the right to amend, modify, terminate or alter the ground lease in any way without the leasehold lender’s consent.
Priority of Ground Lease over Fee Mortgages: The ground lease should include a requirement that any mortgage or deed of trust placed on the fee owner’s interest in the property is subordinate to the ground lease so that a foreclosure sale by the fee lender does not terminate the ground lease.
The provisions above are just a sample of the terms ground lease tenants and leasehold lenders should look for in order to determine whether or not a ground lease is financeable. Successfully negotiating a financeable ground leases requires a strong understanding of these terms. Legal counsel experienced in negotiating financeable ground leases can be a valuable resource for all parties to a ground lease transaction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
