Ground-Rent Arrangement: Meaning, Origin, Pros and Cons

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 are sometimes subject to ground-rent arrangements. Homeowners also use ground-rent arrangements in certain situations. For example, ground-rent arrangements are common for 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 because they often restrict the rights and options of the building owner.

For example, a ground-rent arrangement at a trailer park might stipulate that one of the renters or parties would provide the maintenance for the grounds and areas surrounding the trailers. The ground-rent arrangement might also have established standards for the structure’s appearance and restrict leaseholders from building additional properties or expanding existing buildings.

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.

Origin of Ground-Rent Arrangements

Ground rent and ground-rent arrangements have their roots in English common law. In the U.S., ground-rent arrangements date back to colonial times. Colonists who wished to purchase parcels of land but couldn't afford to do so would agree to ground-rent arrangements instead. They would lease the land from colonial governments or private landowners, making small incremental payments for the use of the land in turn. This would allow them to build a home and develop a homestead without requiring large amounts of capital.

Today, ground-rent arrangements have limited application in the U.S., and states that allow them have codified them into law. In Virginia, for example, ground rent is covered under the Residential Ground Rent Act, which outlines the rights, duties, and obligations of all parties involved in 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—also commonly known as a mortgage—would typically include the cost of the structure and the land upon which the home sits. If the land costs $50,000, and the home itself costs $150,000, the purchase price would be $200,000 for the homebuyer. Assuming no down payment up front, the buyer would require approval for a $200,000 mortgage.

However, if the homebuyer could rent the land 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 because 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 because 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 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.

Disadvantages of a Ground-Rent Arrangement

There are some potential disadvantages associated with entering into a ground-rent arrangement.

Ejectment

Failing to pay the required amount specified under a ground-rent arrangement could result in something called ejectment. Essentially, this means that a homeowner could be forced out of their home if it's determined that they've violated the terms of a ground-rent agreement. For that reason, it's very important to understand the terms of the agreement and what could put you at risk of losing the home.

Collecting ground rent

From the perspective of the person who owns the land, collecting ground rent can sometimes be a difficult prospect. There may be certain steps you're required to take to request ground-rent payments. If the obligated person refuses to do so, that may necessitate taking further action to collect, which can be time-consuming and costly.

Special Considerations

Ground-rental agreements may not be suitable for all homeowners because the landlord can change the terms when the lease ends. For example, the landlord can decide that to use the land 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. The practice of such agreements became widespread from 1915 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.

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