Leasehold: Help with some basics? Renegotiation? Fee available?

Question

Hey everyone, I have been doing some research into the leasehold (LH) market and I am falling short on some of the terminology and what it means. I also cant really seem to find any good resources to learn more. Hopefully the awesome BP community can help!

I think I understand the basics of a leasehold. You can by the lease that expires in XX number of years (say 2050). You pay for that like a loan or cash but it doesn't guarantee that you own the fee for the property after the lease expires. But if the fee is available for purchase, they you can buy the fee if you desire. You can make updates and changes like a normal SFH but you won't see any equity return unless you buy the fee. That pretty much sums up the basics, right?

What about the renegotiation date? What exactly happens when you get to this date, what are you "renegotiating"? Is it not a good idea to buy a leasehold close to a renegotiation date?

Does anybody know of any books or resource that talk about leaseholds? If so I would love to read them. I have been struggling for a little while trying to find any.

I know leaseholds are an uncommon beast (seems like just Hawaii/Honolulu these days), but maybe some of REIs that have done some work in the area can help? @Michael Borger @Jasmine C. @Isi Nau

Daniel Lee · Answer

@Isi Nau dropping helpful knowledge as always ;)

@Nick FrostbutterIf you are interested in a leasehold property there are some options which you may want to consider, if it makes sense for your situation. One is that you buy it now as a leasehold and later on wait to refinance and then buy the fee. Alternately if the lease is long enough you could buy it and then resell it in the future – although leasehold buildings typically do not increase in value, a long lease normally insulates the depreciation.

Just some things to note from a lending side for leasehold buildings, condotels (like the Executive Center, Ilikai Apt Building), and investment properties; please bear with me if you know this already and its already been mentioned in this post:

• -Any loan you get for a leasehold building will need to have a 5 year cushion built in before the end of the lease. So if the lease is up in 2048 (30 years from now) the longest loan you can get is a 25 year loan.

• -Lease fees are not always available for purchase. Of those that are available for purchase, some are restricted to “open seasons” where the fee is available while others are offered continuously.

• -Condotels require a 40% down payemnt.

• -For any investor properties (leasehold or fee simple), depending on your downpayment amount, the building will need to meet certain owner occupancy requirements – this sometimes varies by lender.

• If the owner occupancy is too low you may have to portfolio the loan which will likely result in a higher interest rate.

Those are some tips based on conversations with my lender. Hope its useful and good luck!

Isi Nau · Answer

Hey @Nick Frostbutter

You've been busy!  Good job searching for various opportunities in the market.

Available resources on LH properties are definitely limited.  Like you mentioned, it is not a very common practice outside of Hawaii.

You have a pretty good idea of how it works.  LH is between renting and owning fee simple.  You own the property, but not forever.  In the meantime, you pay a monthly fee to the landowner.  There are some properties where you can purchase the landowner's interest in the land.  But that option is less common.

The renegotiation date is when the monthly lease will be adjusted (inevitably higher).  So if you pay the landowner $300 a month now, at the renegotiation date it may be set at $450 a month (those are just generic numbers to illustrate the concept).  As the renegotiation date approaches, some landowners will inform the occupants how much the lease will be bumped up to.  So if you're looking to buy a LH property and the renegotiation date is close, you can ask if they know what it will be adjusted to.

The expiration date (not renegotiation date) for the lease is a critical component to your strategy for the property.  If the expiration date is less than 30 years away (so 2047 or sooner) it will be challenging to get a loan for the purchase.  It will likely have to be cash.

The expiration date will also effect your exit strategy.  Once that date is less than 30 years away, the value of the property will begin to drop fairly significantly.  So if you are planning to sell it in 10 years, you'll want to make sure there are at least 40 years (or more to give your self a cushion for unforeseeable situations) left on the lease when you purchase.

I have seen some people invest in LH condos with less than 30 years left, but they would have to make enough on cash flow to recoup their investment plus more, since there will be no equity in the property when the lease expires.  The toughest part about this is finding the right property at the right price.  They are rare.  I haven't seen someone complete this strategy from start to finish yet, but I know a few who have gotten into it.

Here's an overly simplified and unverified example of how this strategy would work: purchase a LH condo in Waikiki and use it as a vacation rental.  Purchase price of $200k with 10 years left on the lease.  Positive cash flow is $3k a month.  In 10 years you would positive cash flow $360k (3*12*10).  Minus your initial $200k gives you a net of $160k.  Some people feel they can do much better than this example.  *This is NOT a strategy I would do or recommend to my clients.*  The risk is too high.

Overall, from an investment standpoint I would only consider LH properties with a significant number (50+) years left on the lease, and with multiple, verified exit strategies.

Elijah F. · Answer

No schedule. If the lessee overstays, my guess is that an eviction process could begin.

The only option to prevent a lessee from losing the leasehold property is to buy the leased-fee interest. In Hawaii there is no way to compel the lessor to sell, and no max amount they can sell for.

Karl Marx · Answer

If lease is about to expire in xx years, does the lessor have to follow a specific schedule of notifications, if he wants the lessee to move out?

Can the lessee force the lessor to sell the fee, or are there any other options to avoid the reversion of the property?

Nick Frostbutter · Answer

@Neal Martin From my understanding, yes that's the idea. It can be a way to sort of break up the cost for a buyer I guess, but most likely will lengthen the entire time it may take to to own the property free and clear (assuming you do in fact buy the fee). You could take out separate loans for the leasehold to begin with, then a new loan later for the fee when you purchase it.

I think you can only purchase the fee at the expiration date, but I could be wrong.

Neal Martin · Answer

If the FEE is available is that just the added cost on top of the leasehold? Can you purchase the fee at anytime during the leasehold? Example, from @Nick Frostbutter: purchase $200K leasehold and $400K fee available. Can you purchase leasehold for a year then get additional financing for the $400K after? Or does the fee option typically go away after the leasehold contract?

Elijah F. · Answer

You can google "a guide to hawaii's residential leasehold" for more info. LH is a tricky beast if you don't know what you are getting into. For many leasehold properties, the leased-fee is either not available for purchase or priced really high and many times doesn't make financial sense for an investor. You also need to read the terms of the lease as they are different for different developments. Getting a loan from a bank can be tricky or impossible depending on the remaining term of the lease and renegotiation dates.

Michael Borger · Answer

Not every fee is available for purchase - that's a case by case scenario. You have to ask. If it is available, then yes it's quite easy. You'll just ask the title officer handling your closing to request the fee side to submit their info, or you can contact the agent that handles the fee. Many places will already have a brokerage or broker lined up for any fee sales.

Nick Frostbutter · Answer

@Isi Nau  @Michael Borger Is it pretty straight forward to turn a fee simple condo into a leasehold and sell it to someone? Can most realtors do it? And does it need to be under some sort of company to be the lease rent collector? Or can any old joe shmoe do it?

Michael Borger · Answer

I've done some LH flips before - as long as the numbers add up and you can ensure a buyer on the back end, then go for it. Just be sure you're comparing LH comps, or FS comps if you're going to buy the fee as well. Also, as stated previously, # of years remaining on the lease is obviously a critical factor. IMHO, too many people are scared away by LH properties without having the basic knowledge with which to make a smart analysis.

Leasehold: Help with some basics? Renegotiation? Fee available?

Most Popular Reply