Most people only know of one type of real estate ownership; fee simple, also known as freehold. There are a handful of states that have another form of ownership known as leasehold.
The difference in these two types of land tenure is very different and affects the value of the real estate. It is important to know the difference, especially if you're buying real estate in a leasehold state (i.e. California, Hawaii, New York, Florida).
Why is it so important for me to understand leasehold issues?
AFFECTS YOUR DECISION TO BUY. If you are contemplating the purchase of a residential leasehold apartment unit, there are additional considerations than there are in the event that you were contemplating the purchase of a comparable fee simple apartment unit. For example, you will be concerned with the length of the remaining lease term, what happens to your unit at the end of the lease term, and how increases in the rent payments are determined. Answers to these questions will enforce your decision to buy.
AFFECTS YOUR ABILITY TO OBTAIN A LOAN. As an owner of a leasehold apartment unit, you some day may want to refinance your leasehold apartment unit. A short time remaining on the fixed period or term of the lease could create obstacles to obtain the needed financing. This could be a problem if you wear seeking to refinance either an agreement of sale or a mortgage that is soon to become due and payable in full.
AFFECTS YOUR ABILITY TO RESELL. If you want to sell your leasehold apartment unit, you could find the apartment unit becomes more difficult to sell as the lease term approaches its rent renegotiation and explicit expiration dates. Naturally, a buyer would be more attracted if the lease had a longer period until rent renegotiation or expiration.
Also, lease provisions regarding such matters as the increase of rent and the expiration date of the lease term may seriously affects the willingness of some lenders to finance the proposed purchase of the apartment unit. If, due to the length of the lease term, buyers have difficulty obtained financing, a seller may need to make concessions in order to sell the apartment unit. The value of a unit could decrease as the lease term nears the expiration date.
What is the difference between leasehold and fee simple?
FEE SIMPLE: Fee simple ownership is probably the most familiar form of ownership to buyers of residential real estate. Depending on where you are from, you may not know of any other way to own real estate. Fee simple is sometimes called fee simple absolute because it is the most complete form of ownership. A fee simple buyer is given title (ownership) of the property, which includes the land and any improvements to the land in perpetuity. Aside from a few exceptions, no one can legally take that real estate from an owner with fee simple title. The fee simple owner has the right to possess, use the land and dispose of the land as he wishes--sell it, give it away, trade it for other things, lease it to others, or pass it to others upon death.
LEASEHOLD: A leasehold interest is created when a fee simple land-owner (Lessor) enters into an agreement or contract called a ground lease with a person or entity (Lessee). A Lessee gives compensation to the Lessor for the rights of use and enjoyment of the land much as one buys fee simple rights; however, the leasehold interest differs from the fee simple interest in several important respects. First, the buyer of leasehold real estate does not own the land; they only have a right to use the land for a pre-determined amount of time. Second, if leasehold real estate is transfered to a new owner, use of the land is limited to the remaining years covered by the original lease. At the end of the pre-determined period, the land reverts back to the Lessor, and is called reversion. Depending on the provisions of any surrender clause in the lease, the buildings and other improvements on the land may also revert to the lessor. Finally, the use, maintenance, and alteration of the leased premises are subject to any restrictions contained in the lease.
Important Leasehold terms to know:
- Lease Term - The length of the lease period (usually 55 years or more)
- Lease Rent - The amount of rent paid to the Lessor for use of the land
- Fixed Period - The period in which the lease rent amount is fixed
- Renegotiation Date - Date after the fixed period that the lease rent is renegotiated
- Expiration Date - The date that the lease ends
- Reversion - The act of giving back the property to the Lessor
- Surrender - Terms of the reversion
- Leased Fee Interest - An amount a Lessor will accept to convey fee simple ownership