Fee Simple vs Leasehold Ownership

So you’re browsing listings on HawaiiLife.com and keep seeing this “Leasehold” phrase on condominiums for sale. Seems like quite a few of them! What is a leasehold property? Sometimes you’ll notice condos in the very same building being sold as “Fee Available,” “Leasehold,” and “Fee Simple Properties.” On Oahu, you will find that leasehold and fee simple ownership is quite common.

I am oftentimes asked to explain what is the difference between Fee Simple and Leasehold. These are two very different types of land tenures. While I could seemingly write a book on the subject (yes, there is that much information!), I’ll keep it as simple to understand as possible here. Some basic facts with links for more information.

What is Fee Simple Ownership?

• Fee Simple is the most recognizable and complete form of ownership to purchasers of residential property.
• When one purchases a Fee Simple property, he purchases the entire property.
• In fee simple ownership, you own the land and all the improvements upon the land.
• The fee simple estate owner is entitled to full enjoyment of the property, limited only by zoning laws, deed, or subdivision restrictions or covenants.
• There is no time limit on the duration of fee simple ownership and the property may also be passed along in a will to the owner’s heirs.
• The majority of people that purchase property on the mainland and here in Hawaii choose fee simple ownership.

What is a Leasehold Interest?

• Leasehold is an estate or interest in real property held in a lease agreement with the Fee Simple landowner.
• The purchaser is purchasing the improvements or structures (house, apartment) but not the land. He is leasing the land beneath the improvements.
• The fee simple owner gives another the right to occupy or use the land for a given length of time.
• While the bundle of rights the lease agreement provides for is very similar to the Fee Simple bundle of 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.
• Most leases typically begin as a long term lease, but if the owner of the lease decides to sell his interest, the term does not roll back. It counts down. For example, Buyer Sam purchased a Leasehold property which had 55 years on the lease. Buyer Sam then decides to sell his interest 12 years later to Buyer Cindy. Buyer Cindy’s term on that lease is now 43 years. Sam and Cindy get married…the term is still 43 years. 🙂
• The term years remaining on the lease can have a direct impact on obtaining financing when choosing leasehold ownership.
• Most lease rents will then be adjusted periodically, commonly every 10 to 15 years. Those adjustments are formulated by taking into account the current market value of the land. If the market value goes up, it’s likely that your lease rent will as well.

Why Is Understanding Leasehold vs. Fee Simple Important?

There are some very good advantages of purchasing a Leasehold Property:

• First and foremost, the price! Leasehold property is customarily far less expensive to purchase than a Fee Simple property, thus making your initial investment lower and more affordable.
• The possibility that the lease may be extended or renewed.
• The possibility that the owner will offer to make the “Fee Available” for purchase. Translation? The owner offers 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 a Fee Simple property.
• 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 often times 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 Available” or you negotiate an extension.
• If there is a surrender clause in the lease, the buildings or other improvements may revert to the fee owner.
• Each year, as the lease term ticks down, the property becomes less valuable and thus harder to sell or obtain financing on.
• If there are less than 10 years left on the lease term, financing will not be available, you will have to seek out cash buyers.
• In order to qualify a Leasehold property for 1031 exchange, there must be a minimum of 30 years remaining on the lease.
• In most cases, the Homeowners Association fees are not rolled into the lease rent. They are two separate payments.

Additional Resources About Leasehold & Fee Simple Ownership

I’m including links for more research on Leasehold properties below:

• Element Mortgage – A good place to ask what the terms are on Leasehold lending.
• IRS Pub. 946 – How to depreciate property (Leasehold).
• HawaiiBusiness.com – What is Hawaii Leasehold law?

So, Leasehold or Fee Simple Ownership? Decisions, Decisions!

When choosing between fee simple and leasehold, it all boils down to personal choice. How much time did you plan to own the home? How many years are left on the lease that may affect the saleability, not to mention your “live-ability!” It’s all about choices.

I once had a buyer, 82 years old, purchase a Leasehold condo from me on Waikiki with only 19 years left on the lease. When I pointed this out to him, he chuckled and said, “Well, that will be a problem my heirs will have to address. I’m pretty sure I won’t be here to worry about it!”

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.