How Ground Leases Can Bring Developers A Sense Of Stability In Today's CRE Market

Delinquent commercial real estate loans have reached their highest level in a decade — accounting for 1.6% of total outstanding CRE debt at the end of 2024. This figure has almost tripled from just two years prior, when the delinquency rate stood at just 0.6%. 

Financial pressures such as higher-for-longer interest rates, elevated material costs and labor shortages have created a perfect catalyst for increased loan delinquencies, said Laura Salter, associate at Otten Johnson Robinson Neff + Ragonetti PC.

In response to market uncertainty, traditional lenders have imposed more stringent loan terms to minimize the chance of default. Return on investment has also become less predictable in today’s market, making it hard for deals to pencil.

Ground leases, however, may offer developers a creative way to get deals over the finish line, said Amanda Greenberg, attorney and shareholder at Otten Johnson. 

With a ground lease, a developer will generally lease unimproved ground from a landowner, Greenberg said. Then the developer, at their own cost, will build their own improvements on the land. They are responsible for construction, maintenance, repairs and paying taxes as if they were the owner. At the end of the lease term, ownership of those improvements turns over to the landowner.

“The appeal is viability,” Greenberg said. “First and foremost, developers don’t need the upfront capital or borrowing capacity to buy both the land and finance development and construction all at once. This can be a huge game-changer in today’s CRE environment, where borrowing costs remain elevated.” 

Since developers are only leasing the unimproved land, lease rates are typically lower, reflecting the value of the unimproved dirt, Salter said. These rates are more likely to be subject to low, infrequent, fixed escalations over the life of the initial term and any extensions that are available to the tenants. This contrasts with shorter, more standard lease terms for existing buildings, where rents can escalate annually or every couple of years at fair market value, she added. 

“It wouldn’t be uncommon to see a ground lease with a 10% increase every five years for 60 years, meaning a developer can anticipate its long-term rental costs with the level of predictability afforded by a mortgage,” Salter said.

In addition, since ground leases typically have long terms stretching from 20 to 99 years, tenants often enjoy broad use rights, Greenberg added. This can be particularly beneficial in cases where a developer’s planned use doesn’t endure the test of time and they need to pivot to a different use or operator. 

By that same token, Salter said it is important to negotiate for a right of first refusal under a ground lease agreement. If the landowner wants to sell their land one day, the tenant should have an option to make the purchase. 

“If the property has been a consistently profitable location for the tenant, it might make financial sense for the tenant to purchase it at a fixed point in the term or to be first in line when a third party makes an offer on the land,” she said. “Additionally, a tenant might need to exercise a right of first refusal in order to avoid a situation in which a competitor or other undesirable purchaser would otherwise become the new landowner.”

Greenberg and Salter said ground leases seem to have the greatest impact and relevance in the freestanding retail space. This is largely because ground leases give retailers the ability to grow and break into new markets quickly without finding the capital to buy dozens — or even hundreds — of parcels and open new locations in a short time.

For instance, if a national retailer wants to break into the Colorado market by acquiring dozens of pad sites in all of the state’s major cities, they are embarking on a risky, time-consuming task that may, in the end, not work out as planned, Greenberg said. 

“What happens if they give it a go for five or six years and it's a total flop?” she said. “A ground lease gives them a little more flexibility because they've got slightly less skin in the game. It's sometimes easier to find these sites, too. Finding a site for sale on the perfect block in the perfect town can be really hard to come by.”

Another major factor contributing to ground leases becoming more prevalent in retail markets is the volatility of the sector, Salter added. Retail is the sector most likely to be impacted by consumer demand and spending, which are inherently unpredictable in the long term. 

However, retail isn't the only sector seeing an uptick in ground lease agreements, Greenberg said. Otten Johnson has seen this structure work for financial institutions such as regional banks and even the multifamily sector, which is really “cutting-edge” in this space.

“Anywhere where visibility and location absolutely matter, ground leases are becoming more common,” Greenberg said. 

Greenberg and Salter have worked on dozens of ground leases over the past five years, with Greenberg saying the deal structure has “really exploded.”

“We've done this all over the Rocky Mountain West and also more recently in the Midwest,” Greenberg said. “Unlike other advisers, we're really a one-stop shop for developers because, as a boutique commercial real estate law firm, we can help developers with all parts of their due diligence.”

Otten Johnson can aid its clients from start to finish in ground lease deals, Greenberg said. This includes helping to identify potential opportunities, looking at developers’ existing entitlements and permits, and guiding them through getting their land use approvals. The firm can also assist its clients with their financing structure and negotiating their construction contracts. 

“This is all before we even get to really the meat of the deal, which is the ground lease itself,” Greenberg said. “A ground lease is probably one of the most complex deal structures. It’s a long-term relationship that's going to endure for decades. To do it prudently really does require getting a lot of guidance upfront, so that's where we come in.” 

This article was produced in collaboration between Otten Johnson and Studio B. Bisnow news staff was not involved in the production of this content.

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