Ground Lease - what if Landlord and Tenant doesn't agree on a price?

Question

Hey all,
	
	I'm looking at a 10 year NNN ground lease deal for a buyer. What happens if at the end of the 10 year term, the LL and Tenant can't come to agreement with terms? Is the LL forced to come to terms? What happens to the ground lease?

Thanks!

David Krulac · Answer

@Dylan Tanner

There's a casual sit down eating place here, national chain who has a 10 year lease, no option for renewal.  At the end of 10 years if no agreement is reached the tenant is out.  This is not like residential leases where there are protections for the lease, it over, bye, bye.

A regional eating place in Pittsburgh just closed two of their locations because they could not reach terms with the landlord, lease was up, there is no agreement, the places closed.  Period end of story.

You would think that oh well some other similar business would move in because this is such a great location and remodel the building to suit them.  But not always the case.  There was a supermarket here that went dark and another supermarket wanted to move into the location.  They tore down the old building about 10 years old and built a new building on the same site to their own specs.  So often times the buildings have little or no value unless some other business wants to move in.

A lot of regional and national chains do negotiate lease renewals and options up front going out 30 years.  McDonalds will do leases totaling 30 years for example.  But by IRS rules a lease for longer than 30 years is considered a sale in disguise.

Bill Gulley · Answer

Joel, those lease terms are with improvements, I've never heard of a ground lease outside of agricultural leases being 1-3 years or even 5.

What happens? The tenant is SOL! Any improvement can be removed, tenant evicted. Never heard of any state law requiring renegotiation of a commercial lease.

Sounds like the LL is trying to get over on you at 10 years without any renewal terms. Leasehold interests must be amortized to depreciate any improvement with a salvage value, if any. You would abandon any residual value of any improvement made, not a smart way to go usually, but it depends on what improvement you built. After 10 years you could walk away from a pole barn, not a class A office structure or restaurant.

The least of terms would be 15, could be 3/5 year terms with a set index, it needs to be ascertainable for costing over the term. A straight 10 and then nothing is probably not a good move......depends on what the use is. :)

Joel Owens · Answer

Something is missing here.

All the leases I review clearly define the option periods. Lenders do not care as much for loan purposes because they only count the primary term anyways.

Also if it's a ten year primary term ground lease but 4 years in there is language where the tenant can cancel with a termination clause with 60 days notice etc. then the lender will view the lease as a 4 year and not the 10 year primary. The lender will take the worse case scenario the tenant is using for language in the contract on giving loan and terms to minimize their risk.

The lease usually has a procedure in place for when the option comes available with how much rent will increase and for what amount of time 1 year,5 years etc. In rare cases a lease will talk about a process used at a later time to determine what will be the option rent.

If this is a faulty lease and it mentions nothing this needs to be shored up. Also there needs to be language that the building and improvements revert tot he owner if the option isn't renewed. I can see a mom and pop ground lease being screwed up like this but generally the corp. tenants and owners have great legal counsel and the leases are drafted correctly without these issues.

Ben C. · Answer

Under a typical ground lease the building will become the property of the ground lease owner at completion of the lease. However, the situation you describe seems odd.

Many ground leases are 15 or 20 year base terms with a minimum of two 5-year options. If the tenant doesn't exercise their options then the building becomes the property of the ground lease owner. Or, as mentioned earlier, the building will become the property of the ground lease owner at the conclusion of the tenant's options. At this point the owner can either negotiate a new lease with the tenant or re-tenant the building.

A lease with 10 years remaining with no options doesn't seem right. Have you actually seen the lease?

Based on the part about negotiating with the tenant it almost sounds like there is an option period at "Fair Market Value." If this is the case, there will often be language in the lease that specifies how "Fair Market Value" is determined.

Dylan Tanner · Answer

The tricky part is what if they can't agree on a price. I run into situations all the time where the tenant things the market rate is A and the landlord thinks its B.

How do you 'evict' a tenant from a ground lease?

Paul Falbo · Answer

At the end of the initial lease term, the lease terminates.  Depending on your state laws, if the tenant stays past the original term, then he becomes a tenant at sufferance, subject to any provisions in the lease, including increased rent.  If the tenant refuses to leave, then the Landlord might have to go to court to regain possession.

No party can be forced to enter into a contract.

Most landlords should contact their tenants 6 months prior to the expiration of the lease to see what the tenant's intent is.  Most landlords would love tenants to stay, as they don't want to pay for new tenant improvements and commissions.

Tom B · Answer

If a deal can't be struck, the tenant moves out.  ??

Dylan Tanner · Answer

I'm talking about a lease renewal at the end of 10 years. The term is only at 10 years with no option. what happens if the LL and Tenant can't come to an agreement at the end of 10 years?

Wayne Brooks · Answer

Are you talking about a purchase price, or lease renewal at ten years?  Either way, a price needs to be predetermined, determined by an agreed upon appraiser, or tied to some index.  If it's left as "to be negotiated" then there is no enforceable deal.