Whether you’re just out of college or simply ready to upgrade from living with roommates, you likely know the change will involve various costs and considerations. Most people know you can buy or rent a home, but another option is a leasehold property. If your first question is “what is a leasehold property?” read on to learn more about this viable option.
Understanding leasehold properties
According to Michael Marks, a real estate agent and vice president of client engagement at Locations Hawaii, you’re probably familiar with a type of ownership called fee-simple ownership.
In this arrangement, a fee-simple buyer acquires ownership of the entire property, including the land and buildings. The fee-simple owner has the right to sell the property, give it away, rent it or pass it on to others upon death.
Leasehold properties, on the other hand, are a unique hybrid of renting and fee-simple owning. The leasehold property purchaser (the “lessee”) acquires the long-term right to occupy and use the leased property during the term of the lease.
In this arrangement, the buyer does not own the land but pays a monthly rent to occupy the space. At the end of the lease, the land is returned to the leaseholder (the “lessor”). The lease is very long (typically at least 40 years), and you can typically improve or renovate the property.
You’re still required to pay a small down payment (typically about 10%) in addition to monthly rent, but you ultimately won’t own anything by the end of it.
These arrangements are most common in areas such as Hawaii, New York or Florida, where people are looking for a certain type of lifestyle, such as living near the beach.
What makes leasehold properties so common in Hawaii dates back to the end of the Hawaiian monarchy, Marks said. Much of the land in Hawaii belonged to a few large landowners, such as Bishop Estate. To generate a source of income for the estate without selling their land interests, they began leasing their land to others to be developed.
Currently, the majority of Hawaii’s houses and condos are available to fee-simple buyers, and as a result, these properties are usually priced higher than leasehold ones. Still, some people choose to pursue leasehold properties, despite the setback of not owning the land upfront, Marks said.
Mobile homes are another common type of leasehold that’s increased in popularity over the last 20 or 30 years, said Anna DeSimone, a personal finance expert and author of “Housing Finance 2020: New Mortgage Programs for the New Generation of Homebuyers.”
According to DeSimone, 10% of new homes in America are being built with prefabricated or modular materials. It used to be very challenging to get a mortgage on mobile home parks on a leased lot.
Now, for the most part, anyone buying a manufactured home on leased land is probably going to get a nonconforming loan called a chattel loan with specific requirements for the property itself. These arrangements can be found in essentially any part of the country, though mostly in rural areas.
A big advantage to going this route is that you save roughly a third of your housing costs with a manufactured home, DeSimone said. These homes are a lifeline to the affordable housing industry as the cost to buy a home in America continues to rise.
A manufactured home can cost $50,000 to $70,000, while the cost of buying a traditional home reaches well over $100,000 across the U.S. Those looking for a starter home can opt to buy a manufactured home on leased land without having amazing credit or a high income.
Leasehold property pros and cons
As with any new home arrangement, it’s important to weigh the pros and cons to determine if it’s the right path for you. Leasehold property arrangements are no exception.
Here are a few advantages of leasehold properties:
They generally have some resale value. “This makes owning a leasehold property better than renting, because there is no resale value to renting a unit,” Marks said.
They may be more affordable than buying. Leasehold properties tend to have [lower purchase prices]() than comparable fee-simple properties. This can make them more feasible for those with less purchasing power, Marks said.
It can be more affordable for a certain lifestyle. If you’re just living there and not spending a lot of time at your property, it may be more affordable if you can’t afford to buy a comparable home.
“Leasehold properties can work well for some people, (particularly) those who are very focused on living a great lifestyle and are less concerned about property value appreciation,” Marks said. “One example is buying a leasehold property on the beach and living on the water for a handful of years until the lease expires.”
“A manufactured home on a leased property is a fabulous idea for anyone looking for a vacation home, especially if looking in an area to enjoy activities such as fishing or water sports in areas such as South Carolina, the Florida Keys or certain parts of California, where real estate is known to be expensive,” DeSimone added.
“This a market opportunity for a developer who may be an environmentalist, because there is a lot of rural land and open space that people want to visit to unwind and connect with nature.”
However, there are some drawbacks to this arrangement as well:
It’s a lot like renting an apartment. “Just like when a landlord can always say ‘my sister wants your apartment,’ and require you to vacate within a certain amount of time,” DeSimone said. “Under FHA standards, the landowner would have to give you six months’ notice.”
Similarly, you may have a 99-year ground lease in a community land trust, but if you don’t pay your mortgage, you’re out of there, DeSimone said. And even if you pay all cash for your mobile or manufactured home and are on leased land in a mobile home park, the developer could go bankrupt, leaving you to scramble.
You also don’t have control over the health and safety standards of the land, meaning you depend on the landowner for the hook up to public utilities. If the water is tainted or the electricity goes down, it’s the developer’s problem, DeSimone said.
Leasehold properties generally tend to depreciate. Most people think of owning real estate as something that appreciates in value over the course of time as property prices tend to go up, Marks said.
However, with leasehold properties, the closer you get to the lease expiration (when you, as the lessee, would have to relinquish the dwelling to the owner), the lower the resale value of the property becomes. That’s because potential buyers would have a shorter time frame to dwell in the property before it would be relinquished.
Rent could increase over time. There are set lease renegotiation dates for each leasehold property, and lease rent almost always goes up when those renegotiations occur, Marks said.
Financing can be challenging. This usually depends on how many years are left in the lease. “Any prospective buyer considering buying a leasehold property absolutely needs to consult with a real estate agent experienced in dealing with this type of property, as well as working with a local lender experienced with this sort of property type,” Marks said.
Other forms of leasehold properties
While you can still find a number of available leasehold properties in certain regions, this type of arrangement is actually more common in the commercial sphere.
A common example of a commercial leasehold agreement is a company renting office space or as a retail store. These leases are usually much shorter than those for residential leasehold properties, often lasting one to 10 years.
Commercial leasehold agreements also are usually more complex than residential ones. They typically detail matters such as breach-of-contract and leasehold-improvement clauses, typical landlord and tenant responsibilities, and security deposit requirements.
Commercial leasehold tenants may have better luck requesting terms that benefit them in exchange for leasing their space for a longer period of time.
They may be rare, but they’re also perfect for certain people
While leasehold properties aren’t that common anymore, there are still various factors to consider if you do end up considering this type of arrangement in place of a traditional home purchase or rental agreement.
“Under the right conditions and in certain situations, a leasehold buy can make plenty of sense,” Marks said.
The key is fully understanding the lease terms and balancing any risk. If you are considering purchasing a leasehold or fee-simple property, be sure to make an informed decision.”
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