When financing improvements on leased land, it is important to consider the ways in which an SBA lender can adequately secure its loan. The purpose of this article is to highlight the analysis the lender should complete and documentation the lender should obtain to remain in compliance with SBA rules and requirements when financing improvements for a borrower on leased land, generally known as a “ground lease.”
A ground lease is a type of lease wherein a tenant leases raw land from its owner to develop and improve using its own or financed funds. During the term of the ground lease, the improvements constructed by the tenant remain the property of the tenant, but once the term of the ground lease expires, the improvements on the land become the property of the landlord, i.e., the owner of the land. A ground lease is often called a “land lease” because the landlord leases only the underlying land to the tenant upon which the tenant constructs the building from which it will operate. This type of lease structure is beneficial to both the tenant and the landlord. The tenant is able to obtain property in a prime location which may not be financially feasible to purchase, and the landlord’s property value typically increases once the tenant develops it. The Landlord stands to sell the property for a substantial profit once the term of the ground lease expires. Typically, the tenant assumes responsibility for most expenses of the improvements, including construction, repairs, renovations, improvements, taxes, insurance, and any financing costs associated with the property. For this reason, the ground lease term also tends to be much longer than a typical lease given the additional costs involved with development of the improvements on the property.
SBA loans used for financing improvements on leased land are secured with a lien on the borrower’s leasehold interest in the land by means of a leasehold mortgage or deed of trust. Lenders should consider obtaining title insurance to insure the lender’s lien position on the borrower’s leasehold interest. A lender taking a leasehold interest in the land as security for a loan, would also be required to: (i) follow the appraisal requirements for commercial real estate collateral set forth in the SOP; and (ii) obtain an environmental investigation on the property, the type and depth of which would be determined by the risk of contamination associated with the property and prudent lending practices and internal lending policy of the lender.
The SBA requires very specific information to be included in the ground lease itself in addition to the standard landlord waiver and collateral assignment of lease. In particular, the SOP requires the Lender obtain the landlord’s written consent to the leasehold mortgage or deed of trust and a collateral assignment of the ground lease. If the ground lease has already been executed and does not contain the following provisions: (i) tenant’s right to encumber leasehold estate; (ii) no modification or cancellation of lease without lender’s or assignee’s approval; and (iii) lender’s or assignee’s right to: (a) acquire the leasehold at foreclosure sale or by assignment and right to reassign the leasehold estate (along with right to exercise any options) by lender or successors; landlord may not unreasonably withhold, condition, or delay the reassignment; (b) sublease; (c) share in hazard insurance proceeds resulting from damage to improvements; (d) share in condemnation proceeds; and (e) SBA lender’s or assignee’s rights upon default of the tenant or termination (including notice, extended time to cure (at least 60 days), time allotted for foreclosure and sale, and procedures for non-monetary defaults), the lender should consider obtaining an agreement of landlord encompassing all the foregoing requirements.
For assistance with SBA lender considerations and compliance for transactions involving a ground lease, please contact the attorneys at Starfield & Smith, PC at (215) 542-7070 or visit us at www.starfieldsmith.com.