What is the difference between Leasehold and Fee Simple Properties?
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Whether you are just starting to search for Hawaii Real Estate or a frequent Hawaii property browser, chances are you have seen two words frequently popping up - Leasehold and Fee Simple.
Now, I oftentimes get asked this question and it is a very common question to those who are new to home searching online. These are the two types of land tenure here on Oahu. Here I will explain the difference between Leasehold and Fee simple properties and keep it very simple and easy to understand.
What is a Fee Simple Property?
Fee Simple (FS) properties are the most common form of land tenure in Hawaii and most of the continental United States. Fee simple in layman's terms means that you own the land (or a proportionate interest in the land if it is a condo) and the structure on top of the land (unit if it is a condo) until the end of time. Owners of fee simple properties have no time limit on the duration of ownership and the property may be passed down to the owner's heirs.
What is a Leasehold Property?
Leasehold (LH) properties are a bit more unique to Hawaii. To put it simply, leasehold properties do not own the land, they only own the structure and improvements (the house or condo) for a duration of time. For leasehold properties, there is a separate person or entity that owns the land who gives the Leasehold owner the right to occupy and use the land for a set duration of time. The owner of the leasehold property must pay a monthly lease rent to the landowner to occupy and use the land.
Since leasehold properties have a set duration of time you will see when the lease expires. Most leases initially begin as a long term lease. However, if an owner of a leasehold property decides to sell his or her interest, the lease term does not roll back and continues to count down. When a leasehold property's lease expires there are 3 different scenarios that can occur:
- The best-case scenario: The fee owner decides to sell the fee interest to the leasehold owner. Should the leasehold owner purchase the fee interest they would then make their property a fee simple property.
- The okay scenario: The fee owner extends the lease for X number of years and renegotiates the lease rent.
- The worst-case scenario: The fee owner takes back the land and structure/improvements from the leasehold owner. Under this circumstance, the fee owner does not need to pay the leasehold owner anything (regardless of any improvements made by the leasehold owner).
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(Kahala Beach, one of Oahu's most frequently viewed Leasehold condo complexes)
Important Things To Keep In Mind
- Some landowners offer the fee on an ongoing basis and others do not. If the landowner offers the fee and you are capable of purchasing it, it is normally recommended to purchase the fee as soon as it is offered. The fee typically goes up and there's no guaranty that it will be offered again.
- Pay attention to when the lease expires as it may impact financing options.
- Depending on the circumstance, you may not be able to get a 30-year loan. Most lenders will be conservative and offer a loan program that takes into account the remaining years and minus 5 years from it. So if a lease has 25 years remaining the lender may do a 20-year loan. Sometimes they will also do a portfolio loan.
- You won't be able to exchange a leasehold property that has less than 30 years remaining on the lease. This is because the IRS does not consider the property as real estate.
- If you see a leasehold property that says "Fee Available" then that means the fee is available for purchase and lenders can sometimes roll that into a loan. When purchasing the fee you are purchasing the leasehold property at the purchase price (price is negotiable) + the amount for the fee interest in the land (normally not negotiable).
- The lease rent typically goes up throughout the lease but is fixed up until the "lease renegotiation date." It is common to see this happen every 10-15 years but varies. The adjustments are formulated by taking the current market value of the land. When the market value goes up, it is likely that the lease rent will go up as well.
Leasehold Properties Are Not For Everyone
Normally, many people are better off with Fee Simple properties (owning the land outright). But there are certain situations where owning a Leasehold property may work. Here are just a few examples:
- Investors - Due to the low initial cost of the property, many investors find leasehold properties attractive as they can get a good return on investment (ROI) over the term of the lease. Leasehold properties rent for generally the same amount as fee simple properties. Investors just need to take into account the lease rent.
- Lifestyle Buyers - These buyers typically have multiple properties already in their real estate portfolio and are looking for a property in an ideal location for a fraction of the price. Lifestyle buyers buy to enjoy the lifestyle and aren't aiming to build wealth in the long haul from appreciation.
- Seniors - At some point, some retirees decide that they no longer want to deal with the upkeep and ongoing maintenance of maintaining a single-family house. In this situation, they may decide to sell the house to downsize and keep their assets liquid. Some may even pull out equity from another fee simple property and turn their current home into a rental.
As always, I'm always here if you have or think of any additional questions!
Jonathan Pang (R), BIC, CIPS, CRS, GRI, SRES, CHMS, e-PRO
Locations LLC – Broker In Charge (BIC)
Certified International Property Specialist (CIPS)
Certified Residential Specialist (CRS)
Graduate Realtor Institute (GRI)
Senior Real Estate Specialist (SRES)
Certified Home Marketing Specialist (CHMS)
Mobile: (808) 753-7048
Email: Jonathan.Pang@LocationsHawaii.com
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