Ground-Rent Arrangement

What Is a Ground-Rent Arrangement?

A ground-rent arrangement is a situation in which someone owns a building, but not the land on which the building is located, requiring monthly land-rental payments. Hotels and office buildings sometimes become subject to ground-rent arrangements. Homeowners also use ground-rent arrangements in certain situations. For example, ground-rent arrangements are common with trailer parks and seasonal camper-park resorts.

Understanding a Ground-Rent Arrangement

Ground rent is a rental agreement between a tenant and a landlord. The tenant would pay a fixed fee to the landlord either monthly or periodically. In return, the tenant would have the right to use a specific plot of land. As a result, the tenant owns the property or building on the land but doesn't own the land itself. Ground-rent arrangements require less upfront capital or money when compared to buying both a building and the underlying land on which to build. However, renters must understand the terms of such agreements since they often restrict the rights and options of the building owner.

If the arrangement only allows a structure as large as a double-wide trailer, for example, and the building owner removes the trailer and replaces it with a triple-wide unit, the owner would violate the arrangement. Also, building a detached garage or carport on the premises would break the arrangement. Similarly, remodeling the existing building can sometimes run afoul of such an arrangement.

Benefits of a Ground-Rent Arrangement

There are some benefits to ground-rent arrangements, including helping individuals afford their first home.

Purchasing a Home

A ground-rent arrangement can help with home affordability. Potential homebuyers usually obtain a loan from a bank to purchase a home. The loan, called a mortgage, would typically include the cost of the structure and the land that the home sits on. If the land costs $50,000, and the home by itself costs $150,000, the purchase price would be $200,000 for the homebuyer. Assuming no down payment upfront, the buyer would need to get approved for a $200,000 mortgage.

However, if the land could be rented with a ground-rent arrangement, the mortgage would only need to be for $150,000, and the homebuyer could pay a monthly rental fee for the land. Also, the down payment would be cheaper since it would be calculated as a percentage (say 10%) of the purchase price, which would not include the land.

Of course, the land rental fee would need to be considered when determining whether the borrower could afford the home and the mortgage payments. However, the probability of getting approved for the mortgage would be much better with the ground-rent arrangement. As a result, ground-rent arrangements can help first-time homebuyers, and those with low-to-moderate incomes since it often leads to a smaller mortgage and better odds of getting approved.

Possible Tax Break

The Internal Revenue Service (IRS) allows ground-rent payments to be deducted as mortgage interest under certain conditions. A tax deduction essentially means that the total rental amount that was paid could reduce the person's total taxable income for that year, which would mean a lower tax bill. However, those with or considering a ground-rent arrangement should consult a tax professional to determine whether any tax break would apply to their particular financial situation.

Special Considerations

Ground-rental agreements may not be suitable for all homeowners since the landlord can change the terms when the lease ends. For example, the landlord can decide that the land is to be used for something else at some point in the future, making ground-rent arrangements an unstable method of homeownership. It's important that homeowners understand the terms and their rights within the agreement before purchasing a home with a ground-rent arrangement.

Ground Rent Arrangement vs. Ground Lease

A ground-rent arrangement should not be confused with a ground lease. The latter allows a tenant to develop a piece of land for a specific period of time, after which the land and all improvements revert back to the property owner. These types of agreements often involve 50-year or 99-year leases.

For example, the U.S. government once offered 99-year leases to encourage the development of cabins on national forest land, as part of an effort to spur the use of these areas for recreation. Such agreements became widely used beginning in 1915. This practice lasted until 1960 when the U.S. Forest Service stopped issuing new 99-year leases. These 99-year agreements typically forbade year-round use of the land and the renting out of cabins.

Many also restricted the building of fences. Some also stipulated the type of roofing and other building materials and disallowed the cutting of trees or the diversion of water.

Conversely, ground rent arrangements are not leases with term limits but are instead usually renewable each term as long as the ground rental fees have been paid. Also, ground-leases are typically used for commercial buildings while ground-rent arrangements usually apply to individuals.