Leasehold 101

If you’ve browsed through homes or condos for sale on any of the Hawaiian Islands, you may have noticed many identified as “fee simple,” as well as some described as “leasehold.” Leasehold is not for everyone, but with a full understanding, it just might be right for you. Many Buyers with a full understanding come to see there can be benefits. Wondering about the differences between the two? Here’s a quick overview.

Fee Simple Ownership

A buyer who purchases a fee simple property enjoys complete ownership, meaning they now own all improvements on the land (including any dwellings, buildings, or other structures), as well as the land itself. Or, in the case of a condo, the buyer purchases the unit along with an interest in the land and its common elements. Aside from restrictions such as zoning laws and community covenants, there are no limitations as to how fee simple property may be used. For example, additional improvements can be made, and fee simple ownership can be sold, traded, or passed on to others in a will.

Leasehold Ownership

Some states, like Hawai`i, also have leasehold properties – which may be single-family homes but are more commonly condos. In a leasehold purchase, the buyer enters into an agreement to temporarily possess the structures on the land, while leasing the land beneath, for an amount of time stated in the lease. At the end of that period, a “reversion” is expected to take place (meaning, the land and all of its structures revert back to the landowner).

As the market value of a leasehold property increases, so might the lease rent. However, most leases specify dates when rents will be renegotiated and include caps on future increases. If the owner of the land decides to sell, the leasehold owner will generally have the first opportunity to buy. If a third party buys the land, the original lease term simply continues to count down.

A Few Leasehold Ins and Outs

First, on the positive side: the major advantage of a leasehold property is that it is typically more affordable than a fee simple property. A leasehold owner may also find that the landowner is willing to renew or extend a lease. And finally, a landowner may ultimately decide to make a property “fee available,” meaning that they sell their remaining interest to the leaseholder, at which time it converts to fee simple and belongs to the leaseholder in its entirety.

On the negative side, though, as the lease term becomes shorter each year, the property loses value. As a result, it becomes more difficult over time for a buyer to obtain financing on it. In fact, a leasehold property can only be involved in a real estate transaction such as a 1031 exchange if 30 or more years remain on the lease.

So how do you decide whether leasehold is right for you?

First, consider whether affordability is a primary factor in your decision; leasehold may be a good option if you’d like to minimize cost. A buyer looking for a reasonably priced second home, for example, might find leasehold attractive. Because the initial investment is smaller with leasehold than with fee simple, it may also enable a buyer to afford a larger unit or a more favorable location.

Next, consider how long you might like to own the property, and whether you’d possibly like to pass it along to others. If you’re planning to own for a relatively brief period, leasehold may offer a viable choice.

Of course, for every buyer and every property, there are many subtleties that can’t be covered in a blog post. I’ve personally owned leasehold and have sold many leasehold properties. Let’s talk about your options – Contact me today!

Leslie MacKenzie Smith, REALTOR(S), RS-42147