Ground Leases. Can they be mortgaged?
Though not common, you may not own the land that your building is situated on. You are not a “freehold” owner, but instead hold your interest subject to a long term Ground Lease. Are you still able to get commercial mortgage financing? Yes you are, but you need to understand that lenders view such situations differently.
There are a number of factors Lenders will need to consider:
- The term and amortization period of the proposed mortgage. The lender will want to make sure that the ground lease matures after the leasehold mortgage has been fully repaid. Why? Because the lender will no longer have any security once the ground lease matures.
- The wording of the actual Ground Lease document. Are there any restrictions on financing? Can the Ground Lease be assigned to the lender? Is the Ground Lease the prime lease directly from the freehold land owner, or is it a sub-lease (which would require further review by the lender)?
- The Ground Lease payment obligation. Your payments to the landlord may be constant for years, or may escalate at some point. The future payment may be set, or to be determined, and often based on a percentage of the underlying land value. Why is this an important lender consideration? It speaks directly to your ability to pay the mortgage. If your ground lease payments should double, there may be insufficient income from the property, to adequately pay the mortgage. Predictability of payments is an important lender consideration.
- The leasehold mortgage is provided by way of a sublease. This acts to avoid the lender inadvertently becoming responsible for the obligations of the tenant under the ground lease.
- The necessity of a Leasehold Mortgage Agreement. Why is this important for your lender? Because default by you under the terms of the Ground Lease could entitle the landlord to terminate the lease. The lender’s security would disappear. To ensure that this does not happen, the Leasehold Mortgage Agreement will, require the landlord to give the lender notice of any Ground Lease default, and the ability to cure. The land owner, tenant, and lender will all need to be party to this Agreement.
Your Ground Lease Term
A final word about the length of term of a Ground Lease. Though technically able to provide a mortgage term and amortization period maturing one day sooner than the maturity of the Ground Lease, lenders typically would avoid doing so. Imagine a situation where a leasehold borrower defaults on their Ground Lease. Perhaps there is only a year or two left to maturity. In such a situation, a lender may take control of the property. Seeking to replace the Ground Lessee with a replacement borrower may prove difficult when faced with an imminent Ground Lease maturity.
The important message here is that Leasehold lenders prefer the term of the Ground Lease be significantly longer than the term of the mortgage. A Ground Lease with a relatively short remaining term, will be problematic for financing purposes.