Negotiating Commercial Ground Leases for California and Texas Landlords and Tenants (Part 1)

Negotiating a commercial ground lease in California or Texas can be a complex endeavor, especially given each state’s complex legal landscapes. Before navigating those waters, let us begin with a general description of what a ground lease is: a ground lease involves leasing land, often a raw, undeveloped parcel of land, to a tenant for a multi-year term during which the tenant can develop and utilize that land. Unlike a standard building lease, the ground lease tenant typically takes on all responsibilities of ownership, such as construction, financing, taxes, insurance, maintenance, and repairs) during that term. Ground lease terms are usually very long, commonly 20 to 99 years, to allow the tenant to recoup its investment in any buildings or improvements the tenant constructs. The tenant generally owns any buildings or improvements it erects for the duration of the lease, but at the end of the term, those improvements often revert to the landowner unless otherwise negotiated. This structure can benefit both sides. The landlord retains ultimate ownership of valuable land and enjoys stable, passive income. Meanwhile, the tenant secures a desirable location for its business endeavor without buying the land outright, thereby freeing up capital for the development itself. Ground leases are utilized by numerous industries, from retail chain stores to restaurants on leased pad sites to industrial warehouses or distribution centers on leased land to energy projects  like solar farms, wind farms, and natural gas facilities. Their value lies in any situation where a long-term land use is needed, but purchasing the land is not feasible or desired.

Now that I have explained what a commercial ground lease is, I will delve into how to structure and negotiate one effectively. This Part One covers the initial negotiation of a non-binding term sheet for the ground lease. Part Two will dive into the legal due diligence and lease drafting and will highlight some key differences to keep in mind when dealing with ground leases in Texas versus California.

 

After deciding to pursue a ground lease, the first step is usually to negotiate a term sheet or letter of intent that outlines the key business terms of the lease. This preliminary document outlines mutual understandings between landlord and tenant and sets the roadmap for the deal before the parties invest time and money in drafting a long-form lease. Crucially, a ground lease term sheet is typically non-binding, apart from a few agreed-upon provisions pertaining to exclusive negotiation rights for the tenant, mutual confidentiality obligations, cost-sharing arrangements, and broker commission responsibility. This kind of carve-out is critical because it gives both landlord and tenant the freedom to walk away if due diligence or lease negotiations falter, while still locking in some mutual commitments, such as the promise to negotiate exclusively in good faith for a set period of time. Even though it is non-binding, the term sheet is the foundation of the deal. If something important is left out or misunderstood in the term sheet, it can lead to conflicts or delays later. The term sheet negotiation is also a chance to spot any major deal-breakers early. In the sections below, I will outline the key terms that a good ground lease term sheet should cover and then discuss common red flags to watch for during term sheet negotiations.

Key Terms to Cover in a Ground Lease Term Sheet

A well-drafted term sheet ensures both parties are aligned on the critical business terms before moving forward. Key items to address include:

Land and Title

Clearly identify the land parcel to be leased and confirm that the landlord has good, marketable title to it with no hidden liens or ownership disputes. The term sheet can have the landlord warrant that they own the property outright and that it is not encumbered by any mortgages or liens other than those it disclosed to the tenant. If the landlord cannot make basic assurances about clear title at this stage, that is a red flag because any unknown mortgage, easement, or title defect could undermine the deal. State-specific considerations are important. For example, in Texas a ground lease landlord should disclose if any mineral rights under the property have been severed, or if there are existing oil and gas leases on the land. That is because an unseen mineral interest could allow third parties to access the property’s surface. In California, the landlord should similarly disclose any covenants, conditions, or restrictions of record that could affect the tenant’s use. Additionally, since both Texas and California are community property states, if the property is jointly owned by spouses, ensure all owners—and their spouses, if applicable—will sign the lease.

Lease Term and Rent

Set out the length of the lease and any renewal options. Again, ground leases often run for decades across an initial term and one or more option extension terms. Specify the rent structure clearly, including base rent and any escalations or additional rent. Most ground leases are “triple net”, meaning the tenant pays a base rent plus all property expenses directly for (taxes, utilities, insurance, and maintenance, such that the landlord receives a net amount of rent. Landlords should consider whether rent will escalate over time to account for inflation, such annual or periodic increases possibly tied to a CPI index or fixed percentage bumps. Tenants, on the other hand, want rent predictability and no hidden fees. As such, the term sheet should make clear who is responsible for each such property expense. If the landlord expects any share of the tenant’s revenue or development profits, that needs to be spelled out now. Conversely, if that revenue-sharing is a deal-breaker for the tenant, the tenant should expressly prohibit it in the term sheet.

Permitted Use and Improvements

Define the permitted use of the leased land to make clear what the tenant is and is not allowed to do on the premises. Because ground leases are long-term, use clauses are often kept broad to give the tenant flexibility to adapt over the decades. Tenants will want assurance that they have the freedom to construct and modify improvements without needing the landlord’s approval for every change. Landlords will want to ensure that any such improvements are within the agreed-upon scope of use and comply with the lease terms and applicable law. Typically, during the lease term, the tenant owns any improvements it builds and is entitled to all benefits (income, depreciation, etc.) from those improvements. This point is crucial for tenants and their lenders: if the tenant builds a facility, that building is considered the tenant’s property for the entire duration of the lease. Landlords, however, often negotiate what happens to improvements at the end of the lease. Typically, any buildings or structures revert to the landlord when the lease expires, unless otherwise agreed. A savvy tenant may negotiate an option to either have the right to remove improvements at the end of the lease or to transfer ownership to the landlord and be compensated for their residual value. The term sheet should also address any prohibited uses up front. For example, landlords typically forbid uses involving hazardous materials, illegal activity, or anything that would violate zoning or heavily impact neighboring properties.

Access and Utilities

Since a ground lease tenant will effectively stand in the owner’s shoes during the lease, the tenant must have reliable access to and from the property, as well as necessary utility connections. If the land does not front on a public road, the term sheet—and later the lease—should secure appropriate easements or access rights over any private roads or adjacent land that the landlord owns.  If the landlord owns an access road, the tenant should seek guaranteed, continuous, and unobstructed 24/7 access over that road for the duration of the lease. Further, the tenant should require the landlord to maintain that road to accommodate heavy industrial traffic and to not allow any third parties to interfere with the tenant’s access. If the landlord cannot confirm this level of legal access, that is likely a deal-breaker for the tenant. So good to know this sooner, rather than later. Similarly, discuss how the property will get utilities for water, sewer, electricity, and so on. If infrastructure or utility hookups are not already in place, the term sheet should outline who is responsible for bringing utilities to the site and whether any utility easements are needed on the landlord’s other property. Address any particular infrastructure needs early on. For example, if the project needs an upgraded power supply or a sewer extension, is the landlord contributing or granting easements? Early clarity on access and utilities can save both parties from nasty surprises when construction starts.

Contingencies and Due Diligence Period

It is both common and wise for a ground lease term sheet to include a due diligence or feasibility period before the lease becomes fully binding, much like one would see in a land purchase agreement. During this contingency period, the tenant is allowed time to investigate the property to be sure that the site is suitable for its intended project. That includes investigating such matters as title, survey, restrictive covenants, zoning, environmental conditions, soil suitability, and permitting. The term sheet itself might not list every aspect of due diligence, but it should establish the framework that the tenant will have a window of time to conduct investigations and can terminate the deal, without penalty, if the property does not check out. Essentially, the lease signing is contingent on the tenant’s approval of due diligence. We will delve deeper into the due diligence process in Part Two, but from a negotiation standpoint at the term sheet stage, tenants should insist on a reasonable due diligence contingency. Landlords, for their part, will want to set a reasonable time limit on this period so it is not open-ended. A would-be tenant ought to be wary of any attempt to rush into a binding lease with no contingency. If a landlord refuses to allow any due diligence period, or if a tenant demands an excessively long and unfettered due diligence period, those could be red flags. Both sides benefit from identifying any deal-breakers early rather than after significant money has been spent.

Binding Provisions and Legal Framework

Since most of the term sheet is non-binding, it should explicitly state which provisions, if any, are intended to be binding commitments. Common binding clauses in a term sheet include an exclusivity clause in which the landlord agrees, likely for a fee, not to negotiate with other potential tenants for a fixed time while this tenant works toward a lease, confidentiality obligations for both sides to keep details of the proposed deal private, cost arrangements with respect to attorneys’ fees and any broker commissions, and what state’s law will govern the term sheet and perhaps the lease. It makes sense for Texas law to govern if the property is in Texas. However, if your deal involves parties from different states, say a California tenant leasing Texas land, the governing law could be a negotiation point. It is also wise to include a provision that the term sheet will automatically terminate after a certain date or upon the signing of the final lease, except for the explicitly designated binding provisions that might survive. Having clarity on the term sheet’s status helps prevent confusion or lingering obligations if negotiations fail. In short, even though a term sheet is mostly a handshake agreement, you should still nail down the procedural and legal framework to protect both parties during the interim phase before the lease.

With these key terms covered, both parties should have a solid understanding of the proposed deal. However, even a detailed term sheet can mask potential pitfalls if one side has unrealistic expectations or hidden concerns. The next step in term sheet negotiations is to scrutinize the deal for any warning signs. Below, I outline some red flags that tenants and landlords should watch for at this stage.

Negotiating the term sheet is an opportunity for both sides to spot major issues before investing in a full lease. If something feels off in the term sheet stage, it is far better to address it or walk away now, rather than to have it blow up later. Here are some red flags to keep in mind during term sheet negotiations, first from the tenant’s perspective and then from the landlord’s:

Red Flags for Tenant

Unclear or Overly Restrictive Use Clause.  Be wary if the term sheet narrowly restricts what you can do on the land or requires landlord approval for routine operations. Given the long lease term, tenants need flexibility. For example, a clause that requires the landlord’s consent for any improvements or that limits the business activities too tightly could hamstring your project. If the permitted use language seems too narrow or conditional, treat that as a warning sign and negotiate for more leeway.

No Mention of Access or Easements. If your guaranteed access to the property is not addressed, insist on clarifying it now. A term sheet and lease, if you reach that stage, should explicitly grant the tenant legal access to the premises, especially if a private road or adjacent land is involved. A landlord’s hesitance to grant a written, recordable access right, or silence about how the tenant will get utilities and essential services, is a red flag. You do not want to discover after signing the lease that you lack a legal right-of-way to the nearest public road or that there is no agreement on who provides water and power to the site.

Landlord Withholding Title Information.  If, at the term sheet stage, a landlord cannot confirm that they possess clear title or will not disclose known title encumbrances like easements, restrictions, or liens, that should be cause for concern. For example, if the term sheet omits any representation about existing liens or easements, the tenant should be wary and ask direct questions. If the landlord is unwilling to share basic title assurances up front, that could signal potential problems down the road like a hidden co-owner, an undisclosed loan, or other interests in the property.

No Due Diligence “Out” or Contingency.  Be cautious if the term sheet does not allow you an easy exit after due diligence. Entering a binding long-term ground lease without a due diligence contingency is risky; remember, a ground lease commitment can be similar to buying the land in terms of responsibility and you would not buy real estate without inspecting it. If a landlord is pressuring you to skip a feasibility period or to sign the lease immediately with no due diligence clause, that is a major red flag. A reasonable landlord will expect a short due diligence window, such as 60 to 90 days, for you to vet the property. If that is missing, negotiate it in, or consider walking away.

Landlord Not Open to Financing Provisions (SNDA/Subordination). If you plan to finance the project, which is common given the considerable cost of improvements on a ground lease, the lease will need to accommodate leasehold financing. A financeable ground lease typically allows the tenant to mortgage its leasehold interest and requires the landlord to agree to certain lender protections, such as providing a Subordination, Non-Disturbance, and Attornment (SNDA) agreement and giving the lender rights to cure any tenant defaults. If during term sheet discussions, the landlord flatly refuses to consider any subordination of their own financing or will not promise to work with a lender on typical protections, that could later derail your project when you seek a construction loan. A tenant should view it as a red flag if a landlord will not even entertain the concept of leasehold financing or insists that any future landlord mortgage will take priority over the lease. That is because an unsubordinated mortgage foreclosure could wipe out the lease entirely.

Red Flags for Landlord

Tenant’s Financial Capability in Doubt.  Ground leases often involve significant development expenses. As a landlord, you want to be confident the tenant can actually perform and complete the project, while promptly and consistently paying rent long-term. If a prospective tenant is hesitant to provide any information about their financial strength, or if what they do provide raises questions, you might need additional security such as a guaranty from a parent company, a substantial security deposit, or a letter of credit. Such additional security should be essential if a prospective tenant is a new company with little capital or little in the form of a track record of success in its industry.

Overbroad Tenant Rights That Hamper the Landlord.  Watch out for term sheet provisions that might unduly burden your remaining property or future flexibility as the landowner. For example, tenants often request assurances that their leasehold will not be disturbed by future endeavors by the landlord or third-party tenants in adjacent properties leased by the landlord. One such assurance is that the landlord agree not to encumber the land with any new mortgage unless it is made subordinate to the lease and accompanied by an SNDA protecting the tenant. This request is fairly standard, but consider if any extra rights have slipped in. For example, perhaps the tenant also wants approval rights over what you do with adjacent property you still own, or a clause that the landlord cannot develop anything nearby that might compete or interfere. These could be problematic if not intended. Additionally, consider if a tenant insists upon having a right of first refusal (ROFR) to purchase the land if the landlord ever receives a third-party offer to buy it. A ROFR is common in ground leases, but as a landlord, you should evaluate how it might affect future plans. This ROFR could scare off some buyers knowing the tenant might step in. A red flag would be a tenant pushing for an outright purchase option at a fixed price or other one-sided terms that go beyond the scope of a typical ground lease arrangement. Be mindful of any term that feels like it gives the tenant too much control beyond the lease itself, and address it in the term sheet.

Tenant Insists on Lengthy Free Rent or Early Vesting of Rights.  It is not unusual for a ground lease to include a short “free rent” period during initial construction since the tenant is not using the property yet and is spending money to build improvements. However, be cautious if the term sheet allows the tenant to tie up the property for an excessive length of time without paying rent or without fully committing. For example, an open-ended exclusivity or feasibility period that the tenant can extend easily, all while paying no rent, could leave a landlord in limbo for many months or even years. During negotiations, make sure any free rent or contingency period is well-defined, such as applying only during the set due diligence period or some set number of  months of construction time before rent starts. If a tenant demands the ability to delay the project repeatedly or asks for an unusually long period before rent kicks in, that is a red flag that might indicate uncertainty on the tenant’s part or potential financing issues.

End-of-Term Uncertainty.  Pay attention if the term sheet is silent about what happens at the end of the lease term because landlords and tenants might have very different assumptions. As a landlord, you typically expect that you will regain possession of the land along with any improvements on it when the lease expires. (That can be a significant windfall for the landlord. Imagine getting a building for free at the end of 30 years.) Tenants, however, might be assuming that they can remove their buildings or that the landlord would have to pay for them. It is better to address this upfront in the term sheet rather than clash later. If a tenant pushes back on the idea that improvements could revert to the landlord, or conversely, if a landlord insists the tenant must demolish everything at lease end without any conversation, that fundamental disagreement is a red flag. This uncertainty needs to be resolved before a binding lease is signed because it affects the economics and the long-term value of the deal for both sides.

In summary, the term sheet stage is where both parties should scrutinize the deal and address any big concerns upfront. It is much easier and cheaper to identify a potential deal-breaker or misunderstanding now than after the definitive lease is signed. Both landlord and tenant should consider engaging experienced counsel during this phase to ensure the term sheet is comprehensive and clearly written. A solid term sheet not only captures the business deal accurately but also paves the way for a smoother lease negotiation in the next phase.

In Part Two, I will shift the focus to legal due diligence and drafting the long-term ground lease. At this stage, the tenant works to verify all the assumptions about the property and the landlord works to confirm the tenant’s ability to perform, all before either is locked into decades-long obligations. I will also discuss how involving the right professionals in this phase, like a skilled real estate attorney, can make this process far less daunting.

 

This publication is provided by Amini & Conant, LLP for educational and informational purposes only and is not intended and should not be construed as legal advice. Should the reader seek further analysis of the subject matter or answers to specific questions about the subject matter, please contact the author at joel@aminiconant.com. This publication is considered advertising under applicable state laws.

 

 

 

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