Although leasehold mortgages and assignments of lease are both legal processes relating to property leases, they’re actually very different. A leasehold mortgage is a loan placed on a piece of leased land, usually used by developers for construction projects. An assignment of lease transfers an unexpired lease to someone else, who then takes over the rental payments.
A leasehold mortgage is a loan taken out on a piece of property that is owned by someone else, while an assignment of lease transfers the lease on a property to someone else.
Mortgage Leases and Leasehold Mortgages
Generally, when someone wants to purchase a property, that property is financed using a mortgage. For commercial property buyers, though, mortgage lending isn’t quite as straightforward. There are various types of commercial mortgages, and one of those is a leasehold mortgage.
With a leasehold mortgage, a commercial real estate investor can obtain financing for a building based on the land that person is leasing. Common in real estate development, this type of mortgage gives the developer the funds necessary to put a building on land that is leased, based on the assumption that once construction is finished it will begin generating the income necessary to make it worth it for the property owner.
Assignment of Lease
If you own a home and want to get rid of it, you must either bring in a renter or sell it to someone else. With a lease, though, you can turn over the lease to someone else, provided your landlord is OK with it. This is done through the use of an assignment of lease, which gets you out of an unexpired lease by letting you transfer it to someone else.
Unlike a leasehold mortgage, an assignment of lease is not only a process, but it’s also a title document that both parties must read and sign. This type of arrangement comes in handy if your business fails to become profitable and must close, yet you have a remaining lease on your space. It may also be an option if your business grows so quickly that you need a larger space and therefore must move before your lease expires.
Leasehold Mortgage Versus Lease Assignment
Although leasehold mortgages and lease assignments are different by nature, they also have something in common. They refer to various activities that can take place based on a lease. While leasehold mortgage financing requires taking out a loan, though, a lease assignment is merely transferring an agreement from one party to another.
One similarity between the two is that they both refer to leases, which means property owners may have a stake in the outcome. With a leasehold mortgage, the borrower must have permission to take out such a mortgage – a permission that is usually conveyed as part of a commercial ground lease. With an assignment of lease, the landlord must sign off on the transfer before it can be finalized.
Approvals for Leasehold Mortgages
Getting a leasehold mortgage isn’t just a matter of heading to a bank and asking. The borrower will need to be able to prove that he has the right to request this type of loan. Usually, this starts by looking at the lease and finding the section specific to mortgages on the leased property.
Most commercial ground leases will state that the lessee must provide written notice to the lessor of an impending request to obtain financing for the property. That notice should include contact information for the potential mortgage lender, and the lender should verify that the lease allows a tenant to borrow money from the type of lending institution the borrower has approached.
Approvals for Lease Assignments
A tenant can’t simply turn a lease over to someone else. Obviously, the landlord will have a say in the situation and likely will want to clear the new tenant before approving the transfer. The landlord’s permission is usually granted in the form of a legal document known as the License to Assign.
The landlord’s approval may not be the only thing you’ll need to secure before you can complete an assignment of lease. On your lease agreement, check the section called Alienation, which should detail circumstances in which your landlord can refuse to allow you to assign your lease to someone else. If you fail to go through the landlord approval process, your landlord could later revoke the lease assignment.
Defining a Ground Lease
Before you can establish a mortgage leasehold interest in a property, you first must have the rights to lease the space. Leasehold mortgages are most commonly seen with ground leases, which are commercial leases issued to a tenant who wants to develop property on a lot. The property owner permits the developer to erect a building on that land with the understanding that once development is complete, the land and all the improvements revert back to the owner of that land.
Property owners agree to leasehold mortgages because once development is complete, the owner can then sell the property at a profit. It’s a small price to pay to allow someone to lease the property during the construction phase in order to recoup some money at the end of it. However, it can be risky for the property owner if the person leasing the property stops paying the lease or the leasehold mortgage payment and there’s no one around to pay the rent.
Leasehold Mortgage Foreclosures
If you own a property and stop paying your mortgage, the bank will eventually foreclose. But if you stop making payments on your leasehold mortgage, things get a little more complicated. Someone else owns that property, and that person expects a lease to continue to be paid even if the loan goes bad.
A lender can foreclose on the borrower’s interest in a property, but that same lender likely won’t want to continue to make the rent on that property, even if the owner expects it. Since commercial leases can sometimes run for multiple years, this obligation is something a lender definitely needs to think about. It’s important that agreements be written in a way that the lender doesn’t expressly assume the lease in the event of a foreclosure.
Assignment of Lease Versus Subletting
If you think assignment of lease sounds a lot like subletting, you’re right. But there’s a very specific difference between the two. With an assignment of lease, you are stepping out of the situation and setting up a direct relationship between the new tenant and your previous landlord. With subletting, your relationship with your landlord continues, but you introduce a new relationship between you and a third-party tenant who now pays the rent.
While both processes require legal documentation, subletting puts the agreement between the original tenant and the person who will be staying in the rented property. As with an assignment of lease, though, you’ll need to make sure you have your landlord’s approval before the new person moves in. But neither assignment of lease nor subletting require that you involve a lender, as in the case of leasehold mortgage financing.
Liabilities of Assignments of Lease
As with any type of mortgage lease, when you have a lease on a property, the liability falls on you if you fail to make mortgage payments or you damage the building in some way. When you shift the lease via a legal document, though, this liability goes with it. This only applies if the landlord releases that liability, though, so it’s important to make sure that’s part of your documentation.
Although you may be able to escape liability for what the transferee does to the rental space, there’s one area where liability will probably be unavoidable. If your transferee exits the lease before your original term is up, your landlord will probably come right back to you to fix the issues. Your Assignment of Lease document should detail what will happen in this event, including your right to reoccupy the premises if you choose.
Benefits of a Ground Lease
You may have never heard of these ground leases before, but they’ve definitely happened all around you. Large chain retailers like Whole Foods and Starbucks use ground leases to build new locations on already-owned land, often in situations where they rest alongside other shops and restaurants in a retail strip.
Businesses often choose ground leases with leaseholder mortgages because they can access a property without having to make a considerable down payment. They simply need to obtain leasehold mortgage financing and they can start building. For larger corporations, this is as much a benefit as a slowly growing small business since it keeps capital free for them to spend on other expenses, such as building costs.
Subordinated Ground Lease
When a landlord agrees to a ground lease, often that means agreeing to take a subordinated position if the tenant defaults on her leasehold mortgage. This means your landlord is agreeing that if you don’t make your payments, the property itself acts as collateral. As a result, the landlord may increase rent payments for tenants in order to compensate for that risk.
An unsubordinated ground lease, on the other hand, accounts for any mortgage lease issues by stating that if you don’t pay your rent or your mortgage payments, the property owner takes a top role legally. You may have a tougher time getting a bank to agree to take a lower priority than the landlord and because of this inconvenience, generally, you’ll find the rent is lower to compensate for it.
Leasehold Improvements Versus Leasehold Mortgages
Another term that can be confused with leasehold mortgages is something called leasehold improvements, which can be done without the loan and subsequent mortgage leasehold interest involved in a leasehold mortgage. A leasehold improvement simply refers to adjustments a tenant makes to a property that apply specifically to the internal contents, such as paint, new flooring or upgraded lighting fixtures. This is different from the building improvements that are handled by a landlord and apply specifically to common areas, elevators and other nonrentable areas of a building.
Unlike leasehold mortgages, leasehold improvements don’t involve taking out a loan. The owner may provide a particular amount of money for such improvements, called a Tenant Improvement Allowance. Landlords may also be willing to discount rent or provide money through something called a Building Standard Allowance. In other cases, the landlord himself pays for the improvements in something called a Turnkey Job, which is generally done prior to move-in but can be done while you’re occupying the space, with sufficient notice each time before entering the unit.
Liabilities of Leasehold Mortgages
Before taking a mortgage leasehold interest stake in a property, a lessee will also want to reduce his own liability. If there is a casualty during the time this loan is in place, the developer may find it difficult to get access to the insurance proceeds necessary to repair any damages that were suffered. For that reason, many property owners will employ an escrow agent to hold the funds so that they’re guaranteed to only be used for damage-related costs.
If there’s an injury or another incident on your property during the time you hold a lease, local laws will determine where responsibility falls. Landlord-tenant law covers such a situation, and often landlords have insurance to protect against these types of claims. Although you, as the developer, have a responsibility to keep your worksite safe, the landlord is responsible for ensuring common areas are maintained and proper signage is posted when a hazard exists on site.
- USLegal: Leasehold Mortgage Law and Legal Definition
- JDSupra: When a Lender Forecloses on a Leasehold Interest
- White and Williams LLP: Leasehold Financing: Key Issues for Mortgage Lenders
- What Is A Ground Lease? | Massimo CRE Coach
- LawDepot: What Type of Leases Do You Have?
- Sherin and Lodgen: Why a Leasehold Mortgage?
- FindLaw: Liability for Tenant Injuries and Insurance for Landlords
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.