SUBORDINATED VS. UNSUBORDINATED GROUND LEASES

There are two main types of ground leases: subordinated and unsubordinated. And the difference is what happens if a tenant runs into financial trouble during the lease term.

Subordinated Ground Lease:

In a subordinated ground lease, the tenant agrees to be a lower priority when it comes to any other financing the tenant obtains on the property. For example, let's say that you sign a ground lease on a parcel of land, and then borrow $500,000 to build a restaurant on it. If you default on the loan while under a subordinated ground lease, your lender can go after the property (including the land) as collateral.

Unsubordinated Ground Lease:

On the other hand, in an unsubordinated ground lease, the tenant has higher priority than any other lenders when it comes to claims on the property. In other words, the tenant's lenders may not foreclose on the land if they default. In the event of default, a lender on a property in an unsubordinated ground lease may be able to go after the assets of the business but cannot take full control of the property as they may be able to in a subordinated ground lease.

Obviously, with all things being equal, landlords would want to sign unsubordinated ground leases. After all, why would a landlord want to risk their property? In practice, landlords generally have to charge lower rent on unsubordinated ground leases in order to entice tenants to accept such an arrangement. Many lenders won't originate loans to build commercial buildings on ground leases unless they have the recourse to take control of the property in the event of the tenant's default.  Unsubordinated ground leases are the more common arrangement. Even though they generate less rental income, landlords typically don't want to put their property at risk, essentially taking an active stake in the tenant's business.