Ground Lease vs. Fee Simple in Net Lease
How ground leases and fee simple net lease deals differ in risk, pricing, depreciation, and reversion, and how to choose between them.
The basic difference
In a fee simple net lease, the investor owns the land and the building, and the tenant leases both. In a ground lease, the investor owns only the land. The tenant leases the land, builds or owns the building, and pays ground rent, typically on a long, net basis.
Ground leases are common for quick-service restaurants, banks, coffee shops, and other outparcel users who want to control their own building. Many ground leases run 20 years or more with multiple options.
Why ground leases are considered lower risk
In a ground lease, the tenant has invested its own capital in the building. Walking away means abandoning that investment, which gives the tenant a strong incentive to keep paying. If the tenant defaults or the lease ends, the improvements typically revert to the landowner, which can give the owner a building it did not pay for.
The landowner also usually has no building obligations at all, since the tenant owns the improvements. That makes ground leases among the most passive net lease investments. Lenders financing the tenant's building may require the ground lease to include protections such as notice and cure rights, which investors should expect.
Trade-offs: pricing, growth and taxes
Lower risk usually means lower yield. Ground leases generally trade at lower cap rates than fee simple deals with the same tenant. Rent growth in ground leases is often modest, such as increases every five years, so total return depends heavily on the long-term value of the land.
Taxes also differ. Land is not depreciable, so a ground lease owner gets little or no depreciation deduction, while a fee simple owner can depreciate the building, generally over 39 years for nonresidential property, and may accelerate some deductions through cost segregation. For investors who value tax shelter, fee simple is often more attractive.
How to choose
Ground leases suit investors who prioritize safety, passivity, and long-term land value, such as those near the end of a 1031 chain or planning to hold for decades. Fee simple suits investors who want higher current yield and depreciation, and who are comfortable underwriting the building's condition and any landlord obligations.
Whichever you choose, read the reversion clause, options, rent schedule, and any provisions on leasehold financing, casualty, and condemnation. In a ground lease, also confirm who gets the building at the end of the term, and whether the tenant must demolish it.
Frequently asked questions
What happens to the building at the end of a ground lease?
It depends on the lease. Most ground leases provide that the improvements revert to the landowner when the lease ends, but some require the tenant to demolish the building and return a clear site. Read the surrender and reversion provisions carefully, since they affect long-term value.
Can you depreciate a ground lease investment?
Generally very little. Land is not depreciable, and in a ground lease the tenant typically owns the building and takes the depreciation. The landowner may be able to depreciate certain land improvements it owns, but the tax shelter is much smaller than in a fee simple deal.
Why do ground leases have lower cap rates?
Investors accept lower yields because the tenant has invested in the building and is strongly motivated to keep paying rent, the landowner has few or no property obligations, and the land may gain the building at reversion. These features make income more secure, so buyers pay more for it.
Are ground leases good 1031 replacement properties?
They can be. Fee ownership of land subject to a ground lease is real property that generally qualifies as like-kind. Ground leases suit exchangers who want passive, long-term income, though lower cap rates and limited depreciation may not fit investors seeking higher yield or tax shelter.
Educational content, not tax, legal or investment advice.