Leaseholds: A Brief Education
In the Oahu real property market, you’ll often see certain properties, especially (but not always) condos, that are priced waaaayy below comparable properties.
I get inquiries about these all the time, and I can usually tell by the hope in the voices I hear over the phone that people are eager to believe they’ve stumbled onto that most fabled and rare of real estate creatures: the “screaming deal.”
In pretty much every case, though, the simple truth is that this particular homebuyer has found a leasehold property for sale. Leaseholds are common in Hawaii but not elsewhere. Throughout most of Hawaii and the rest of the U.S., fee simple is the most prevalent form of real property ownership.
Leasehold vs. Fee Simple
To understand the difference between leasehold and fee simple, think of a single family home. In a “fee simple” arrangement, you own the house and the land. It’s the kind of ownership you normally think of when owning real property.
"fee simple = complete ownership of the land and improvements"
By contrast “leasehold” typically means you own the house but rent the land under it. At the end of the so-called “ground lease” you may have to remove the house or surrender it. This basic idea gets a little complicated when applied to condos, but the gist is the same.
"leasehold = temporary ownership of the land, the improvements, or both"
There’s nothing necessarily wrong with leasehold properties. It just requires some more due diligence and it fits a narrower set of buyers’ circumstances. To discern the difference when searching for properties online, look for the label “land tenure.” Next to that you should find “LH” or “leasehold,” or you’ll find “FS” or “fee simple.” Be aware, though, that not all search websites include this information.
Key Points for Buyers
Most ground leases start off running for 99 years or so. However, most leasehold buyers take ownership of their properties somewhere in the middle of that time period. It’s very important to know a few things about the particular leasehold property that you’re looking at. But first:
"Think of buying a leasehold as prepaying part of your rent."
With that in mind, consider the following 6 points:
1. Lease Rent
This is the part of your rent that you don’t prepay. When you purchase a leasehold, economically it’s the same thing as prepaying the portion of your rent that is associated with the improvements — the house or condo — that you’re going to be living in. The lease rent, though, is the part of your rent associated with the ground under the improvements. So, just like any other real property rental, you need to make your monthly payments for the ground lease rent. If the property is a condo, the lease rent is usually (but not always) paid separately from the monthly maintenance fees.
2. Lease Expiration
Every ground lease will have an expiration date associated with it. The sooner the expiration date, the cheaper the purchase price for the leasehold. This fact explains the Holy cow, why is this property so cheap!? experience that tricks so many unwitting buyers when they’re surfing Zillow.
3. Lease Renegotiation
With most ground leases, rents are fixed for 10 to 20 year periods, after which the rents are “renegotiated.” What that really means, of course, is that the lease rent will go up.
4. Fee Availability or Purchase
“Fee” is a weird word in real estate. We use it in a way that doesn’t jibe with everyday usage. When you see the fee available for purchase, that means that the owner of the leasehold can pay the ground lease landlord some set amount to convert the property from a leasehold to a fee simple. Most of the time, when you see a leasehold property for sale that has a fee available, just add the leasehold price to the fee price and you’ll get a total that makes the property very comparable to prices for similar fee simple properties already on the market.
5. Prices: Up or Down?
Most often leaseholds depreciate because the closer you get to the end of the lease, the less usage of the property you have left and thus the less value one can extract from the property. However, just like regular fee simple properties, leaseholds respond to scarcity and other market forces, so on rare occasions they do appreciate.
6. Getting a Loan
Local banks will usually lend on a leasehold if it meets certain criteria. Most commonly, banks require that the loan term end at least five years prior to the end of the lease term. Usually buyers obtain 30 year loans on fee simple properties, though they can be shorter. To buy a leasehold with a 30 year loan, the lease couldn’t expire until at least 35 years past the purchase date. However, I have heard of banks that require up to 14 years’ difference between loan term expiration and lease expiration.
Are Leaseholds Bad Deals?
NO! Well, really, it depends. A lot of people are put off by the whole idea of owning a leasehold property. It takes a little more due diligence and thought to evaluate whether there’s an economic advantage or risk in buying a leasehold, but otherwise it’s a fairly straightforward means of property ownership.
Investors, in particular, should evaluate leaseholds because when “deals” pop up on the market, they most often appear in the leasehold segment. But even the regular buyer can find a decent emotional and economic deal in a leasehold.
Leaseholds are most common in the Waikiki area of Oahu. Many of these properties are in high rises, and there is a strong tendency for them to be small hotel-like condos known as “condotels.” They may not have full kitchens and may only be 250 square feet in size. Banks don’t usually like to lend on condotels, so when you find a leasehold property that is also in a condotel, it becomes pretty difficult to get financing for your purchase. However, by no means does that description fit all leasehold properties on Oahu.
For smaller condotel properties you may need to pay for your leasehold purchase entirely in cash (meaning money you don’t borrow, not those green papers in your wallet). Other leaseholds can be financed, but you’ll need to identify the right lender to assist you with that.
Evaluating a leasehold requires some more intensive thinking and research than fee simple properties. If you’re willing to put in some effort a leasehold might be a fit for you.