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Lease vs. Fee

You’ve been browsing listings on The Waikele Group website and keep seeing something called “Leasehold” on properties for sale. In fact, there are quite a few of them! This looks like a good deal! Why is the property so cheap, you ask? Why do they seem to be priced lower than other similar properties? Sometimes you’ll notice condos in the very same building being sold as “Fee Simple,” “Leasehold,” and “Fee Available.” What does all this mean?

In the State of Hawaii, many residential condominiums and coopera­tive apartments (units) are leaseholds. With a leasehold property, the costs of development go to buildings and other improvements rather than to land acquisition. As a result, these residential leasehold projects have been attractive opportunities for developers, investors, and owners, and generally accepted by lenders in Hawaii, for more than 30 years. Buyers are attracted to leasehold units primarily because of the apparent initial low cost to purchase, but also because of location, building amenities, and unavailability of comparable fee simple properties.

To lease or fee, that is the question?

Well, ok, that is not exactly a properly worded question. The real question is, is it more advantageous to purchase a leasehold property, rather than a fee simple property? the question always arises where agents are asked to explain the difference between Fee Simple and Leasehold. These are two very different types of land tenures. While there is a wealth of information on the subject, I will attempt to keep it simple with some basic bullet points and links with more information.

What Does Fee Simple mean?

  • Fee Simple is most common to purchasers of residential property.
  • When the buyer purchases a Fee Simple property, the buyer purchases the entire property from land to improved structures built on top of the land.
  • The property owner owns the land and all the improvements upon the land.
  • The property owner is entitled to the full enjoyment of the property, limited only by zoning laws, deed, easements, subdivision restrictions or covenants.
  • There is no time limit on the duration of this ownership and the property may also be passed along in a will to the owner’s heirs.
  • The majority of property sold on the mainland and here in Hawaii is Fee Simple.

What do you get when you buy Leasehold?

  • Leasehold is an interest in real property held in a [long term] lease agreement with the Fee owner.
  • The purchaser is purchasing the improvements or structures (house, apartment) but not the land. The land beneath the improvements is leased (or rented).
  • The owner gives the purchaser of the improvements the right to occupy or use the land for a given length of time.
  • While the rights of the lease agreement are very similar to the Fee Simple rights, there are several important differences to note.
  • The buyer of a Leasehold property does not own the land beneath the improvement, he purchases the right to occupy and use the land and he must pay rent on it.
  • His use of the property is limited by the remaining years indicated on the lease. That period of time will be stated in the lease.
  • When the lease term expires, the land returns to the owner.
  • Leases will typically begin as a long term lease, but if the owner of the lease decides to sell his interest, the term does not rollback. It counts down. So what began as a 50-year lease, 30 years later is now only a 20-year lease.
  • The number of years remaining on the lease can have a direct, and possibly negative, impact on obtaining financing.
  • Most lease rents are reevaluated periodically, commonly every 10 to 15 years. Those adjustments are formulated by taking into account the current market value of the land. Lease rents may be adjusted upward as market values increase.

Why Is This Important to You?

There are some very good advantages to purchasing a Leasehold:

  • First and foremost, the price! A leasehold property is customarily far less expensive to purchase than a Fee Simple property, thus making your initial investment lower and more affordable.
  • There is the possibility that the landowner may choose to extend or renew the lease.
  • The owner may offer to make the “Fee Available” for purchase. Meaning, the owner may offer to sell his remaining interest in the land to you (the leaseholder). The cost of the fee is based on the value of the underlying land and the remaining length of the lease. Once purchased, the once Leasehold property converts to Fee Simple.
  • If purchasing a Leasehold condo with the “Fee Available,” many lenders will roll that into the loan.
  • The cost of a Leasehold mortgage payment is oftentimes less than the rent on a comparable unit.
  • Possible tax credits back through depreciation.

So, What’s the Bad News?

There are also some disadvantages of Leasehold ownership:

  • At the end of the lease, you have to give back the land, unless you are offered the fee or you negotiate an extension.
  • If there is a surrender clause in the lease, the buildings or other improvements may revert to the owner.
  • Each year, as the lease term ticks down, the property becomes less valuable and thus harder to sell or obtain financing on.
  • There is a high probability that if there is less than 10 years left on the lease term, that financing will not be available, you may have to seek out cash buyers.
  • If doing a 1031 exchange on a leasehold property, there must be a minimum of 30 years remaining on the lease.
  • In most cases, the Home Owners Association fees are not rolled into the lease rent. They are two separate payments.

In the end, it all boils down to personal choice

So the question remains, Leasehold or Fee Simple? Decisions, Decisions!

So in the end, it all boils down to personal choice. How much time d0 you plan to own the home? The number of years left on the lease may affect the saleability, not to mention your “live-ability!” It’s all about choices.

If you do decide to take a serious look at Leasehold property on Oahu, I would recommend that you seek counsel with an attorney well versed in Leasehold contracts, just to make sure you understand the entire process.

If you would like to know more about buying or selling Hawaii real estate, please contact us.

Additional Resources

Here are some additional links on Leasehold properties:

 

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