Unraveling the Choices in Commercial Real Estate Leasing
When it comes to commercial real estate leasing, landlords and tenants have several options to consider. Two common types of leases are ground leases and fee simple leases. Each holds unique advantages and considerations for both parties involved. In this article, we will explore the key differences between these leasing options and their implications for landlords and tenants, with a focus on triple net leases and commercial real estate investment.
Ground Lease: Unlocking the Potential of Land Ownership
A ground lease is a long-term lease in which the tenant rents land from the landlord, gaining the right to develop and utilize the property during the lease term. The tenant is responsible for constructing and maintaining any improvements to the property, while the landowner retains ownership of the land. Because the landlord only owns the land, they have zero responsibility to the building and cannot take depreciation. After the lease term ends, the landlord assumes all improvements the tenant made to the property.
Fee Simple Lease: Absolute Ownership and Control
A fee simple lease, also known as an absolute triple net lease, is a traditional lease where the landlord retains absolute ownership of both the land and any improvements to it, leasing both to the tenant. The tenant has no ownership of the building or land, but assumes full responsibility for property management and all associated costs.
Evaluating NNN Leases within Ground Leases and Fee Simple Leases
Triple Net Lease in Ground Lease
In a ground lease with a triple net lease arrangement, the tenant bears the responsibility for all property-related expenses, including taxes, insurance, and maintenance costs. The landlord enjoys a steady income stream without the need to manage property management tasks. The landlord only has ownership of the land until the lease term ends or the tenant vacates the property, after which the building ownership goes back to the landlord who may re-tenant the property.
Triple Net Lease in Fee Simple Lease
Within a fee simple lease with a triple net lease structure, the landlord retains absolute ownership, while the tenant assumes all property management and maintenance obligations. This lease type offers investors the potential for long-term passive income without direct involvement in property upkeep. Absolute NNN leases are typically offered to creditworthy or investment grade tenants with a credit rating of BBB- or higher.
Choosing the Right Lease Option: Factors to Consider
Risk and Control
Ground leases offer landlords the advantage of retaining ownership and control over the land, while giving the tenant the autonomy to make decisions regarding the property.
Both lease options are generally long term and are well-suited for long-term investors. That said, Ground leases are generally longer and are a good choice for those who wish to generate passive income from land assets, whereas fee simple leases appeal to investors seeking complete ownership and more active involvement in property management.
Ground leases allow tenants to develop the property according to their business needs, while fee simple leases retain some landlord control over property improvements and renovations.
Additional Points to Consider
- The length of the lease term is a key factor to consider, as it will affect the tenant’s investment horizon.
- The rent payments in a ground lease are typically lower than those in a fee simple lease, as the tenant is not responsible for the cost of the land. The lower rent generally means they can be purchased for a lower price.
- The tenant in a ground lease may be required to make periodic payments to the landlord for the cost of property taxes and insurance, but generally they are structured as net leases with the tenant paying for those expenses directly.
- Both lease types offer consistent monthly income with little to no involvement from the landlord. The creditworthiness of the tenants as well as corporately backed leases can provide some additional investment stability.
Making the Best Decision for Your Commercial Real Estate
Choosing between a ground lease and a fee simple lease involves various considerations, including investment goals, risk tolerance, and desired levels of involvement in property management. Both leasing options offer unique benefits for landlords and tenants, with NNN leases providing an additional layer of stability and income potential for investors in commercial real estate.