Understanding Leasehold and Fee Simple Properties in Hawaii Real Estate
As you look for homes for sale in Hawaii, sometimes you will come across a smoking hot deal. A deal so good, in fact, that it seems too good to be true. In many cases, these listings are for a leasehold property.
I can help you determine whether buying a leasehold property is the right fit for you, walking with you every step of the way as you search for a home in Hawaii while living on the mainland or on the island. Contact us any time to learn more!
Two Types of Properties in Hawaii: Leasehold and Fee Simple
While leasehold properties are not exclusive to Hawaii, many of our clients come from a real estate market where this term is non-existent. A leasehold property can be a confusing concept if you are unfamiliar with it.
Fee-simple properties are the most common, making up 98% of real estate in Hawaii and the vast majority of all real estate throughout the mainland. This is likely the type of purchase you picture when you are thinking of buying a home. In a fee-simple transaction, you purchase the land and all of the structures on it, and it will remain in your ownership until you decide to sell or otherwise forfeit the property.
Leasehold properties make up the other 2% of the real estate market in Hawaii. When you purchase a property as a leasehold property, you are buying the structure on the land, but the land itself is being leased to you. Think of it the same way as leasing a car. You pay a certain amount of money to use the car for a specified period of time and then you would turn the car back over to the dealer when the lease is up. All of the unique terms of the lease will be laid out in an agreement, and at the end of the lease term, there is a reversionary clause that states the unit or home would revert back to the landowner. The land owners essentially have three main chooses at that time. They can choose to take the unit or home back as specified in the lease. They can renegotiate a new lease, or they can sell the land to the property owner.
History of Leasehold Ownership in Hawaii
Leasehold ownership may sound like a strange format for those coming from other real estate markets. Understanding the history of this type of homeownership will help it make a bit more sense.
Hawaii has historically been a real estate market that is out of reach for many buyers, with a lack of affordable options for those on a conservative budget. Property values have many hopeful homebuyers wondering how they can afford the cost of living in Hawaii. Leasehold properties presented a solution that is a bit of a compromise between renting and owning.
When it began, the leases usually had a 99-year term, which meant due to the long lease, they were a more affordable option to a fee simple property. The leasee of the home would likely sell the home or pass on before the land lease was anywhere near expiring.
As time has gone by, the lease term for leasehold properties has become much shorter in, and many of the 99-year land leases are coming close to the end of their term. To limit the damage of a massive number of land leases ending at the same time and displacing homeowners, the government offered a tax incentive in 2000 to leasehold land owners to sell the land to the homeowner. At that time, many leasehold properties were converted to fee simple by selling the land to the homeowners. That incentive allowed for many leasehold properties to convert to fee simple during that time, but the incentive no longer exists, so lease to fee conversions may not be as likely now.
FAQs about Leasehold Properties in Hawaii
How long is the lease?
The lease length on a leasehold property can vary greatly. Originally, many leasehold agreements were for 99 years, but as time goes by the leases get shorter and shorter. No two building leases are the same so you will see a wide range of lease lengths and terms. They will not be a matter of months like a rental property, though unless they are nearing the end of their lease.
In the leasehold agreement, there will be an outline for when the lease payments might have a periodic step-up, and when things can be renegotiated. Before signing on to a leasehold property, make sure to take the time to go through the agreement carefully with an agent who understands this type of transaction (like us!).
Remember, when you buy a leasehold property, you may be purchasing the home in the middle of the lease term. For example, a homeowner can sell you a home they have owned for 8 years with a 20-year land lease, and you will be signing on for the remainder of the lease which is a 12-year land lease. You need to be prepared for what may happen at the end of those 12 years (which will come faster than you think).
What is the benefit of buying a leasehold property instead of a fee simple?
As you look into the details of a leasehold property, you may be wondering what the point of this complicated arrangement would be. Leasehold properties are not for everyone, but remember the primary benefit here is financial.
You can buy a leasehold property for less, and sometimes significantly less, than a comparable home that is fee simple. Those "too good to be true" deals you see online really can be a way to get into homeownership for less than you imagined possible. Your monthly mortgage payment (if the lease is long enough you can get financing to purchase the unit or home) may make homeownership affordable for you to get into. If things worked out in your favor you buy the home now for less than a similar home that is fee simple, and then if you were lucky enough to have the landowner offer you the ability to purchase the land in the future then you could potentially own the property in fee simple.
What are the risks of owning a leasehold property?
The risk of buying a leasehold property is the unknown. The land owner may have in the lease renoegotation periods where the amount of the lease rent paid per month can be renegotiated. Also the landowner, can choose to decide not to sell the land to you at the end of the lease, leaving you in a tough predicament in either case. While it may work out in your favor and you can buy the land, convert the property to fee simple, and have an increase in property value, you cannot count on this.
When I bought my first property in Hawaii I bought a leasehold condo. The landowner had died and the heirs inherited the property. I felt the heirs might want to cash out. It was a risk I was comfortable taking, and it ended up working out. The heirs, now owners of the land, were happy to sell to me and convert to fee simple. This worked out well, but remember that is not the common experience and there was an element of luck for me.
When is buying a leasehold property the right choice?
There are a few times that buying a leasehold property is a great idea:
- Buying fee simple is not affordable for you, but leasehold properties with decades left on the land lease would allow you to own the home for a few years, allowing it to build some equity before you sell and move on to fee simple. If there is enough time on the land lease, this is likely to work out well.
- You are looking for a place to retire and the length of the land lease is likely to outlive you, and you don't mind not having an asset to pass on to future generations.
- You are looking for an affordable lifestyle property that you can use and enjoy and are not concerned about future value.
- You are comfortable with the risk involved, and the conditions of the lease look like you may end up with an opportunity to buy the land in a few years.
The key to buying leasehold properties is working with someone who understands them. With both personal and professional experience, I understand the risks and benefits and can help you every step of the way. Contact us any time to learn more!