Leasehold Investment Properties – Savvy or Scary?

“I’ve found my dream home in Hawaii and I want you to help me buy it,” says the enthusiastic buyer on the other end of the line. A real estate agent’s dream come true! But the euphoria is short lived when you realize that your buyer is interested in an “affordable” leasehold property. Explaining how the purchase of a leasehold property works is like crushing someone’s dream, but for some buyers, it can be the perfect opportunity to get into the vigorous Hawaii real estate market.

Purchasing a home typically means you buy both the structure and the land it sits on. In a leasehold purchase, you purchase the structure and rent the land it sits on. So while conventional wisdom says that you should invest in property that will increase in value during your time of ownership, buying a leasehold property comes with a different set of considerations.

Ask Questions and Run the Numbers

Shifting the purchaser’s focus to “what can the property do for you now” is an important first step. Here are some things that a buyer should ask when considering a leasehold property:

• What is the monthly lease rent?
• How many years are left on the lease agreement?
• When will the lease be renegotiated?
• Will the fee be offered in the future?
• What kind of income can the property generate?

One of my clients purchased a unit at the Diamond Head Beach Hotel that will serve as a great example of making an investment in a leasehold property. Here are some numbers:

• $107,000 – Purchase price of studio unit in Diamond Head Beach Hotel (Cash*)
• $275.64/mo. – Lease Rent
• $393.00/mo. – Maintenance Fee (Includes cable tv, water, sewer, and electricity)
• Monthly fees for lease rent and maintenance fee = $668.64

The lease rent on Diamond Head Beach Hotel is to be renegotiated on 12/31/17, meaning that the current lease rent amount will increase by an unknown amount. However, with a thorough examination of the documents provided by the association and a look at past increases, one can get a sense of the probable increase. It is important to consider whether an increase in the lease rent changes the numbers enough to reconsider the purchase.

The lease agreement on the Diamond Head Beach Hotel is set to expire on 12/31/32, which means that from the time of purchase to expiration, my client will have owned the property for 16 years.

This would be a good time to discuss what happens upon expiration of the lease agreement. Several things can happen, the lessor can renew the lease, they can offer the owners the option to purchase the fee, or they can take the property back from the owners. Yes, that sounds terrifying, but let’s return to the shift of thinking on purchasing a leasehold property.

My client renovated the unit, hired a property management company at 18% a month, and is now renting the unit for $145-180/night and enjoys a 98% occupancy rate. Providing a monthly positive cash flow.

Renovations

Living Area – Before

Living Area – After

Bathroom – Before

Bathroom – After

Kitchenette – Before

Kitchenette – After

Risk Assessment

So does the monthly income for the next 16 years outweigh the potential loss in value as the lease expiration date approaches? Obviously, this is an individual decision, but shifting the belief that yielding a sizable monthly income as opposed to long term equity, could prove to be a savvy move.

See more photos of my client’s property here.

Want to learn more about investing in a leasehold property? I am happy to help!

*The example used was a cash purchase. For more information on guidelines for obtaining financing for a leasehold property, please contact me.