Lenders are often asked to provide financing secured by a leasehold interest in land evidenced by a ground lease. A ground lease is an agreement between the fee owner of real estate (the ground lessor or landlord) and its tenant (the ground lessee) in which the fee owner leases the land to the tenant. Ground leases are typically for a longer term than a basic space lease and allow the tenant to construct improvements on the land and operate the improvements during the term of the ground lease. Because the collateral for leasehold financing typically consists only of the leasehold rights of its borrower under the ground lease, lenders should carefully review the terms of the ground lease to ensure that it contains certain minimum lender protections.
An astute drafter of a ground lease will consider a future mortgage of the ground lease in its initial preparation of the lease, but often, critical lender protections are not included, and this is especially true of older ground leases. While a landlord is generally not interested in amending the terms of the ground lease to satisfy the requirements of a lender providing leasehold financing, a landlord should understand that the tenant’s interest in the ground lease must be financeable.
In addition to the protections in a lender’s leasehold deed of trust, a lender will often need to request that a ground lease be amended or that a separate agreement regarding ground lease be executed to address any lender protections that may have been omitted from the initial ground lease. Below is an overview of the minimum protections that a lender should consider when financing a loan secured by a ground lease.
In the event that some or all of these provisions are not contained in the ground lease, a leasehold lender should request that either the ground lease be amended to include them or that the landlord execute and record an agreement in favor of the leasehold lender in which the landlord grants the lender with these rights. In addition, it is good practice to have such agreement incorporate, or have the landlord provide an estoppel certificate as of closing, which confirms that (i) the ground lease has not been amended or modified, (ii) the tenant is not then in default under the ground lease, (iii) all agreements between landlord and tenant are contained in the ground lease, (iv) the landlord is not aware of any prior assignment of the tenant’s interest in the ground lease, and (v) that the landlord has no current right to terminate the ground lease. The lender should have the right to request an estoppel certificate from time to time to confirm that the tenant remains in compliance with the ground lease during the term of the loan.
A tenant’s leasehold interest in land can serve as a valuable piece of collateral, but leasehold lenders must carefully review the ground lease and take the necessary steps to ensure that certain protections are included in the ground lease or in a separately negotiated agreement between the landlord and lender.
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