Fee Simple vs Leasehold

by | Jun 21, 2020 | Buying Real Estate, Selling Real Estate

When purchasing property, especially if it’s your very first property, price plays an important factor in the decision making process. When looking at the Oahu MLS, you may have noticed a simple FS or LH next to the listing price. These two letters are distinctions in the property type, “Fee Simple” or “Leasehold”. What is the difference between leasehold vs fee simple?

What is a Leasehold Property?

Leasehold is a type of property in which the owner has the rights to control the improvements on the land (such as live in it), but doesn’t own the land itself. It gets even more complicated when the leasehold property type is a condominium! As the name implies, leasehold properties come with a lease, that must be paid on a monthly basis. This is similar to a rental type of lease. Each lease has a fixed term until it expires and can easily start for 90 or more years! When the lease ends, the lease owner will get to decide whether or not they want to extend the lease or take the property back for themselves.

Leasehold is an older type of property type which is losing popularity in Hawaii. It is almost nonexistent in the mainland. That being said, if searching for real estate in Hawaii, it is very important to look out for the difference. The other option, fee simple, is the “normal” type of property that most people will stereotypically think of when buying or selling real estate. When purchasing fee simple properties, you own the land as well as the building it’s on.

Should I Buy a Leasehold Property?

So, if you still have to pay a monthly lease “rent” why even consider a leasehold property? While it will depend on who owns the lease, lease rents are usually no where near the cost of a normal rental price. Generally speaking, it could be several hundred dollars a month. It is nothing different than how condo owners will pay a monthly association fee to the building they live in (leasehold properties in condos however have to pay lease rent fees PLUS association fees).

Leasehold Advantages:

1) Leasehold Properties are Always Cheaper:

The MAJOR advantage to purchasing a leasehold property is the price. Because the property is not entirely owned by you, you won’t be paying the entire price! The price for a leasehold property will be dependent mainly on the length of the lease. The shorter the lease, the less it is worth. This is a major advantage for those that do not have the intention of living in a property for a long period of time, such as the elderly or people looking to move in the near future.

2) Leasehold Conversions to Fee Simple:

Even if your intention is to live in the property for a long time, it is often possible to convert a leasehold property into a fee simple one. This is called “buying the fee.” Because this is in essence an extra step and more of a hassle for the buyer, buying a leasehold property and then purchasing the fee is often cheaper than buying a similar property that is already fee simple. I have seen savings in excess of 15% using this methodology.

3) Positive Cashflow for Rentals:

Another advantage of leasehold properties is that if you purchase one to rent out, you will often have positive cashflow. Hawaii rentals for fee simple properties often have negative cashflows of several hundred per month!  This is due to the general excise tax and high cost to purchase. Putting a down payment of 20% or more might only make you break even! This is not even taking into consideration the cost of making repairs that can happen at any time.

If you have a leasehold rental, you may see several hundred dollars per month in profits. For aggressive investors, buying a leasehold condo in Waikiki that is approved for vacation rentals can see over a thousand a month in profit!

Leasehold Disadvantages:

1) Monthly Lease Rent:

Unfortunately, leasehold property types have many disadvantages, which is why they are less desirable. While the price may be a major advantage, the lease is the big disadvantage. I know I mentioned that many buyers are used to paying an extra monthly fee, such as an association fee, but who really wants to pay another monthly fee? Despite the smaller size, the fact that it’s called lease “rent” is actually a little painful to the ego. Didn’t you just get out of paying rent?

2) Decreasing Value:

Another disadvantage to the lease is that the longer you own the property, the shorter the lease gets. The closer the lease gets to expiration, the lower the value of the lease becomes! This means the longer you own leasehold properties, the lower the value gets! This is the EXACT OPPOSITE of what happens with fee simple properties, that gain in value or appreciate the longer they are owned. In my opinion, this is the biggest disadvantage of owning leasehold real estate.

If the lease length for a leasehold property is very long, such as over 50 years, it is true that the property can appreciate in the short term. It is extremely important to keep track of the expiration date as we will discuss later.

3) Mortgage Difficulty:

Mortgages aren’t very risky for a bank because they can always use the real estate as collateral. Since leasehold properties actually decrease in value, it is much less attractive for a bank to create a loan when the property may actually be worth less than the loan amount in several years. Add this to the fact that a typical mortgage lasts for 30 years, but a lease might be less than that period. Getting a mortgage is extremely difficult when buying a leasehold property. Banks will not even consider issuing a mortgage if the amount remaining on the lease is fifteen years or less. As a result, assume you will have to buy leasehold entirely with cash or put a significant down payment, such as 30% or more.

4) Lease Ending Uncertainty:

When the lease ends, the lease owner will get to decide whether or not to renew the lease or take the property back. If the lease is renewed, the lease owner can increase the lease rent to what is fair market value. In some situations lease rents increase dramatically, possibly doubling or even quadrupling. Expect this to happen in an area that has been revitalized or if the lease renegotiation occurred several decades ago.

If the lease owner decides to take back the property, then you can be evicted at the end of the lease! Normally, the leaseholder is very transparent about what they intend to do when the lease ends, especially as the lease gets closer to expiring. If you do not pay attention or read your notifications, you could quickly find yourself out of a house. One of my clients, who exclusively owned leasehold properties, didn’t do their due diligence when buying one for a rental. He didn’t realize that he bought a condo with a lease less than five years old. Realizing his error when the lease had less than three years left, he discovered that the leaseholder was going to take back the property! He ended cutting his losses by selling at a deep discount for about 65% less than what he bought it for several years earlier.

In instances such as these, very savvy investors will attempt to renegotiate the lease with the leaseholder. Sometimes they can extend the lease after buying the property for almost nothing. It is never guaranteed though and very risky.

Real Estate is Rewarding in the Right Situation

While it may not be for everyone, hopefully you now understand the difference between the regular fee simple property and leasehold types. It is very possible to get a great deal if you look at the LH properties too. So take a look, but be careful.

When in doubt, it is always a great idea to get advice or help from a real estate agent. Remember, hiring one to help you buy is absolutely free! If you would like help in your current or future home search, we would love to start the process with you. Let us help you find the home of your dreams!