Ground leases are long term-leases that share many of the characteristics of a land purchase. The ground lessee acquires long-term exclusive rights of possession, including the right to build on and use the property as the lessee sees fit and to obtain any depreciation or other tax advantages that may accrue by virtue of owning income producing land.
The main difference between a ground lease and a land purchase of a Mobilehome Park is that, rather than paying for the underlying land value at the outset, the ground lessee makes rental payments over time which can be financed by, for example, Park revenue. Another significant difference is that, at the end of the useful life of the Park, the ground lessee might be able to walk away from the property with no further obligation, such as park closure costs.
A ground lease’s delayed acquisition costs, flexibility of use, tax potential advantages, and set time period of obligation can be a desirable outcome for a Park developer/operator. A ground lease can help minimize the costs to develop a mobile home park, while obtaining the benefits of tax depreciation for the improvements. A ground lease can also help reduce the investment exposure to the limited life span of the Park. And a ground lease can help the ground lessee avoid potential Park closure costs.
The ground lessor benefits from the regular income stream and no development risk. Some ground lessors may share in park profit and the value of the ground lessee improvements in addition to retaining the residual fee interest at the end of the lease term.
Key issues that arise in Park ground leases pertain to the extent of landlord representations and warranties regarding the “bare” land and existing improvements, contingencies regarding government permitting, what portion of net park income will be shared with the ground lessor as a percentage rent (if any), and what obligation the ground lessee will have to rebuild in the event of major damage, destruction or a government taking of the property.
Ground lease provisions that merit special attention given the long term nature of the arrangement are provisions requiring adequate levels of insurance, the payment of taxes resulting from any property reassessment, and a strong requirement to arbitrate any future disputes.
Lender and sublease provisions have a prominent role in any ground lease under current market conditions. Regardless of the current financial position of the ground lessee, the ground lessee will want future flexibility to encumber the leasehold value of the property and use institutional financing. Typical institutional lender provisions deal with lender notice, right to cure, right of substitution, foreclosure and attornment.
In a normal ground lease situation, the ground lessee abandons whatever valuable improvements exist are in place upon termination of the ground lease, and the ground lessor becomes the owner of those improvements. That may work out well for the ground lessee operating a mobile home park, who will want to avoid closure costs that could include payment for substantial costs. While termination of the ground lease may seem a distant event and while park closure laws may change significantly in the future, if the termination provisions of the ground lease are not carefully crafted with the end in mind, they can result in the obligation to close a park to the detriment of the ground lessee. Conversely, a ground lessor, if the lessee is not required to be diligent in repair and maintenance, could inherit a park with substantial deferred maintenance.
To summarize, a ground lease is a flexible tool that can provide many advantages for mobile home park owner/operators over a typical land purchase deal. But care must be taken in the negotiation of its key provisions to ensure that the ground lease does not end badly, for either party.
*Hart | King Partner, emphasizing real estate and land use transactions, J.D. University of Virginia School of Law