Fee Simple vs. Leasehold vs. Fee Available

While browsing through the listings for your new home on the Big Island you may be coming across the phrase “Leasehold,” Fee Simple,” and “Fee Available. This is particularly so for many condominiums on the market. A buyer might find a building that could have several condos for sale with one being sold as “Fee Simple,” one as a “Leasehold,” and another with as “Fee Available” making it a challenge to understand the difference.

So what are these terms and what do they mean to you as a buyer?

Fee Simple

• Fee Simple is the most complete form of ownership for buyers of residential properties.
• To purchase a Fee Simple property, simply means that the entire entire property has been purchased; land and structures.
• In a Fee Simple transaction, the buyer owns the land, structures and improvements on the land.
• The owner is now entitled to the full enjoyment of the property and is limited only by the areas zoning laws, the deed-of-trust, and any HOA or Association fees, restrictions or covenants.
• The buyer has no time limit of this ownership and the property may be passed as the owner deems to the heirs or to other buyers as determined in a will or by a property sale.
• The majority of property sold in Hawaii is Fee Simple.

Leasehold

• A Leasehold purchase is when a buyer purchases interest in a property or estate and engages in a lease agreement between the leaseholder and the Fee Simple land owner.
• The buyer in a Leasehold agreement purchases only the improvements and structures – in most cases a house or an apartment – but does not have any interest in the land. The leaseholder leases the land beneath the improvements from the Fee Simple land owner for an agreed upon length of time.
• The bundle of rights for the buyer in a lease agreement is very similar to the Fee Simple bundle of rights, however, there are several important differences to note.
• The buyer of a Leasehold property does not own the land beneath any of the improvements made on the land or any structures on the land. The Leasehold buyer is purchasing the right to occupy the land and essentially paying a lease payment to the landowner for it’s use.
• The length of time that the buyer has use of the property is negotiated with the landowner and stated in the leasehold agreement. When the leasehold term expires, the land returns to the owner.
• A long term lease with the landowner is the most typical, however, if the lease owner decides to sell their interest, the terms of the agreement do not start over.

As an example: George, a buyer, purchases a leasehold property with a 55 year lease agreement. Ten years later, George decides to sell his lease to another buyer, Rebecca. Rebecca has now purchased from George all of the structures and improvements made on the land, however, the lease agreement with the landowner remains intact and so will now be only 45 years for Rebecca. The lease does not begin again with a new leaseholder. Say, after another 10 years George and Rebecca decide to get married. The terms of their lease agreement will then be 35 years.

The Pros

A Leasehold property has some compelling advantages:

• One of the most important for many buyers is the price! A  Leasehold property is commonly much less expensive than a Fee Simple property making your initial investment lower and much more affordable.
• The landowner could offer to make the property “Fee Available” opening it for purchase. Fee Available is when the owner decides to sell his interest in the land to you as the leaseholder. The cost is then calculated based on the current value of the land and the remaining length of the lease. The Leasehold property then becomes a Fee Simple property.
• If you are purchasing a Leasehold condo with the “Fee Available”  option, lenders will often combine them into one loan.
• A Leasehold mortgage payment is typically less than the rent on a comparable unit.
• There are possible tax credits that come back to the buyer through depreciation.
• Leasehold agreements can offer a lot of flexibility for a new home buyer.

The Cons

There are also some disadvantages of Leasehold ownership:

• The most obvious being that at the end of the lease you have to give back the land, unless you are offered the Fee Available option or you are able to negotiate an extension.
• Some lease agreements include a surrender clause, stating that if you default on the lease the buildings or other improvements revert to the owner.
• As the lease term expires year by year, the property loses some of it’s value making it harder to sell or obtain new financing on.
• A lease with less than 10 years left on the term, will be unable to get financing and will have to find cash buyers.
• The remaining years of the term lease can have a direct impact the buyer’s options in obtaining financing.
• Most lease agreements are adjusted periodically, usually every 10 to 15 years. Those adjustments take 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.

Decisions, Decisions

In the end, it all comes down to what you need and want when purchasing a new home. How long do you want to own this home? Some buyers are only looking for a few years in a home while others are looking to live out their lives there. Is there a Fee Available option being offered? How many years are left on the lease? Are you in a position to take on a shorter lease? What is your age? Will you be moving in a few years due to a job? Do you plan to retire in this new home? It’s all about where you are in your life.

There’s a story about one buyer who was 82 years old. He was purchasing a Leasehold condo with only 18 years left on the lease. When his realtor pointed this out to him, he smiled and said, “Well, I’m pretty sure I won’t need to worry about that!”

If you are looking into a Leasehold property for the first time, it is highly recommended that you seek counsel with an attorney who is well versed in Leasehold contracts. They understand the process and will guide you through the loopholes.

If you have any questions about Leasehold, Fee Simple, or Fee Available properties on the Big Island, please give me a call.