What is a ground lease?
A ground lease rents land to a tenant who builds its own improvements. The landlord keeps the leased fee, the tenant holds the leasehold, and when the term ends the improvements revert to the landowner. Virginia's recording statute makes a written contract, or a deed conveying any estate or term, void as to purchasers for value without notice and lien creditors until it is recorded where the land lies.
Fee simple, leased fee and leasehold on the day the lease is signed
Before a ground lease is signed, the owner holds the land in fee simple. Signing splits that ownership in two, and the Comptroller of the Currency's lending handbook names all three interests.
Fee-simple interest is the ownership as unencumbered by any other interest; leased-fee interest is an ownership interest held as a landlord (the lessor) with the rights of use and occupancy conveyed by a lease to a tenant; and the leasehold interest is the right held by a tenant (the lessee) for use and occupancy as conveyed by the landlord.
Office of the Comptroller of the Currency, Comptroller's Handbook, Commercial Real Estate Lending
| Interest | Held by | What it carries |
|---|---|---|
| Fee simple | The owner, before any lease | Ownership with no other interest against it |
| Leased fee | The landlord, or lessor | Ownership, with the rights of use and occupancy handed to a tenant for the term |
| Leasehold | The tenant, or lessee | The right to use and occupy the land for the term, and the improvements it builds there until they revert |
What makes the lease a ground lease is who builds. The handbook describes land leased to a tenant that constructs its own improvements, and it says banks may finance either side: the land that is leased, or the tenant's improvements on the leased ground.
The landlord's side is ownership of the land itself, and Va. Code 55.1-101 says no estate of inheritance or freehold in land is conveyed except by deed or will. The tenant's interest is different: subsection B says a lease or other written document conveying a non-freehold estate, entered into after February 13, 2019 or in effect on that date, is not invalid or unenforceable because the conveyance was not in the form of a deed.
Leasing a graded building site rather than selling it is one of the ways such a site changes hands, which is part of the discussion of what a pad site is.
The tenant's building counts for less as a loan's collateral each year the reversion comes closer
The feature that separates a ground lease from an ordinary sale of a lot is the ending. The tenant pays for the building, and the building does not stay the tenant's.
At the end of the ground-lease term, the leasehold improvements revert to the lessor. For this reason, the value of a collateral leasehold interest diminishes over time and has no value upon maturity of the lease.
Office of the Comptroller of the Currency, Comptroller's Handbook, Commercial Real Estate Lending
That one sentence explains most of how a ground lease is financed. A lender making a loan against the tenant's leasehold is lending against something that shrinks toward zero as the term runs out, so the years left on the lease matter to the loan. The handbook also says that in calculating debt service coverage, the ground rent should be deducted as an expense: the tenant's income has to carry the rent to the landowner before it carries the loan.
The landowner sees the other side of the same arithmetic. It collects ground rent for the term and holds the reversion at the end. How a stream of rent is turned into a value is the subject of what a cap rate is and how income becomes value.
The handbook's own caution is short: "Ground lease arrangements can be quite complex." It adds that banks often engage legal counsel to review the lease documents before committing. Whether a tenant's lender can take a deed of trust on the leasehold is a question for the lender and an attorney.
An unrecorded lease is exposed to a later buyer without notice, and leasing part of a tract raises a plat question
A ground lease runs for years, and the land under it can be sold, borrowed against or inherited during that time. Virginia's recording statute is where the question of an unrecorded writing starts.
shall be void as to all purchasers for valuable consideration without notice not parties thereto and lien creditors, until and except from the time it is recorded in the county or city in which the property subject to such contract, deed, or bill of sale is located.
Va. Code 55.1-407 A
The section applies that rule to every written contract and every deed conveying any estate or term. Read against a long lease, the exposure runs to later purchasers of the land for value without notice and to lien creditors: as to them, a writing not yet recorded in the county where the land lies is void. A buyer's title search reads the land records, which is where a recorded lease would show. Drafting the lease and deciding what to record is an attorney's work.
Leasing only part of a parcel raises a separate question. Carroll County's Land Use and Planning page treats any division of a lot or parcel as a subdivision under the county's subdivision ordinance, with plat approval and recording before any piece is sold. Whether a ground lease of part of a tract counts as a division is the county subdivision agent's answer, not a listing sheet's.
Tax on the tenant's building is its own question too. Who is assessed for improvements a tenant builds on land it does not own is a question for the commissioner of the revenue in that locality.
Where a long leasehold is treated like real estate, and where the method stays rare
A leasehold is not ownership of the land, but federal rules treat a long one as close to it in at least one place.
The Treasury regulation on like-kind exchanges, 26 CFR 1.1031(a)-1, lists among its examples of exchanges where no gain or loss is recognized a taxpayer who is not a dealer in real estate who "exchanges a leasehold of a fee with 30 years or more to run for real estate". Whether a given lease fits that example is a CPA's answer, and how an exchange works is covered in what a 1031 exchange is.
Federal land acquisition appraisal standards treat the ground lease more cautiously. The Uniform Appraisal Standards for Federal Land Acquisitions reserve the capitalization of ground leases for rare cases where the property is subject to a long-term ground lease, and even then treat it as additional support for the sales comparison approach rather than the primary method.
Two neighbors share the word lease and little else. A hay or pasture lease rents ground for farming rather than for a tenant's building, and what happens to a farm lease when the land sells is its own question. An option gives a party the right to buy on set terms later, which is covered under what an option contract on land is.
Thinking about leasing your commercial ground instead of selling it?
Before answering a ground lease proposal, send Lowell the parcel: he can put an opinion of value on it as an outright sale for comparison, while the lease terms stay with your attorney. No cost, no obligation.
Got it. Thank you.
We'll be in touch shortly with an honest read.
Questions this raises
Who owns the building when a ground lease ends?
The landowner, under the arrangement the OCC describes. The OCC's handbook on commercial real estate lending says that at the end of the ground-lease term the leasehold improvements revert to the lessor, which is why a leasehold's value as loan collateral diminishes over time and has none when the lease matures. The terms of a particular lease are read by an attorney.
What happens if a ground lease is never recorded in Virginia?
Under Va. Code 55.1-407, a written contract or deed conveying any estate or term is void as to purchasers for valuable consideration without notice and lien creditors until it is recorded in the county or city where the property is located. The statute's reach is purchasers and lien creditors who are not parties to the writing; whether and how to record a lease is an attorney's decision.
Does a long ground lease have to be written as a deed in Virginia?
No. Va. Code 55.1-101 requires a deed or will to convey an estate of inheritance or freehold, but subsection B says a lease conveying a non-freehold estate, entered into after February 13, 2019 or in effect on that date, is not invalid or unenforceable because it was not in the form of a deed.
Where this page's facts come from
Every rule, office and figure above traces to one of these. Rules change; check the office before you act on one.
- Comptroller's Handbook, Commercial Real Estate Lending, Version 2.0, March 2022 Office of the Comptroller of the Currency
- Va. Code 55.1-101, conveyance by deed or will, and leases not in deed form Code of Virginia
- Va. Code 55.1-407, unrecorded contracts and deeds void as to purchasers without notice Code of Virginia
- 26 CFR 1.1031(a)-1, property held for productive use in a trade or business or for investment Electronic Code of Federal Regulations
- Uniform Appraisal Standards for Federal Land Acquisitions U.S. Department of Justice
- Land Use and Planning: any division of a lot or parcel is a subdivision Carroll County, Virginia