How Leasehold Works
Basically, you pay the landowner rent for the land your property is on for a fixed term. When the term expires the land reverts to the lessor and all ownership rights are canceled (your property reverts to the landowner). Most leases have renegotiation dates where the land lease amount is renegotiated for another set term. The lease amount will increase and the increase is often multiples of the previous amount.
In some cases, a buyer of a leasehold property may have the opportunity to buy the land as part of the purchase of the improvements, if the fee is available. “Fee” in this instance means owning the land. Some landowners offer fee ownership on an ongoing basis. It never hurts to ask if the fee is available to purchase when looking at a leasehold property.
If the fee is not available, it's imperative you find out everything you can regarding the lease terms and the landowner’s plans. Here is where the professional help of a Locations agent is worth its weight in gold.
Your Locations agent can advise you on how long the lease term is, when it will renegotiate, or if it recently has, and can explore other options regarding the property. It’s possible that a fee offering is planned or perhaps the landowner can be persuaded to sell the fee to you. Should the fee not be available, there are financing considerations that leasehold buyers should understand:
- You may not be able to get a 30-year loan - Most lenders will only make a loan for 90% of the remaining term of the lease. For example, if the lease term has 30 years remaining, the lender will offer a 27 year loan.
- Leases with less than 30 years remaining, the IRS does not consider the property as real estate. You won’t be able to exchange the property, or defer any capital gains taxes.
- If you already own a leasehold property, pay attention to any fee offerings. It's generally recommended to purchase the fee as soon as it is offered. Don’t wait. There are no guarantees you’ll get another chance, and the cost of the fee often increases over time.
Leasehold has Risks
Purchasing leasehold properties has risks. Make sure you understand the lease terms clearly before moving ahead. Even leases with long terms often have renegotiation dates which can interfere with financing. For example, if there is a renegotiation date within 5 years of purchase, the lender may use an estimated renegotiated lease rate to qualify the buyer. Lease rents are added to the loan payment when determining if the buyer qualifies for a loan. The higher estimated renegotiated rate may be too high for the buyer to qualify for the loan – even though they can qualify at the current lease rent amount.
Leasehold can also be difficult to re-sell. Unlike Fee Simple properties, leasehold properties often lose value over time. Why? The term of the lease gets shorter. This can make re-selling the property difficult.
Leasehold is not for Everybody
Most people are much better off with Fee Simple - owning the land outright. However, in some situations, a Leasehold property may work.
- Investors - With a low initial cost of the property, investors can get a healthy ROI over the term of the lease. Leasehold properties rent for the same amount as similar fee simple properties.
- Lifestyle Buyers - Buyers that aren't in it for the long haul or to build wealth. These buyers usually have multiple properties in their portfolio and can get a Leasehold property in an ideal location for a fraction of the price.
- Seniors – For retirees who don’t have heirs to leave the property to, or who want to take their equity out of a fee simple property, Leasehold can be a way to downsize for retirees and keep most of their assets liquid.
- College Students - Leasehold's can give college students a quality place to live throughout school then make rental income after they graduate. The trade off will be the lack of property appreciation over time.
Contact your Locations agent for more information and to see if a Leasehold property is right for you.