Aloha Coast Realty’s Blog of the Big Island

One of the areas of Hawaiian real estate that is not clear to a lot of people from the mainland is the issue of “leasehold” versus “fee simple”. If fact, this confusion (especially on the mainland) is so prevalent that I’ve had people say to me “well, you can’t own property in Hawaii, can you?”. Of course, that is completely false. While fee-simple ownership is the most complete form of ownership, its not as if leasehold ownership is without any of the rights or privileges of ownership.

It is true that until recently, up to 85% of all non-governmental land was occupied under a long-term lease. However, in recent years that has changed. There have been a lot of legislative changes, as well as changes in public opinion that have lead to more land becoming available through fee-simple ownership.

Let’s start by defining the terms:

Leasehold: the land remains in the hands of the underlying owner (the “lessor”), however, the lessee (the person occupying the property) has a long-term lease giving them the right to use or sell the improvements on the property. Since many leases are 55 years or longer, this has the effect of the giving effective ownership to the leaseholder. The leaseholder just never owns the underlying land.

Fee simple: this is the type of ownership that most people know. You own the land, you own what’s on the land and you own them both forever or until you decide to sell.

Leased Fee: this is the interest in the property that the underlying owner (“lessor”) has in the property. Sometimes, the person, trust or entity will decide to sell their interest in the property and will offer the “leased fee interest” in the property to the existing leaseholders.

In Hawaii, leasehold property is still common. Its far less common on the Big Island and actually, its quite rare on the Hilo side of the Big Island. Of the properties on the market at any one time, less than 5% are leasehold, at least here (it is more common on other islands).

Leasehold properties can be bought and sold just like any other, with this one big caveat and exception. A leasehold property always has an end date – and on that end date, the current leasehold owner may have nothing. It seems strange, but you can live in a house for 30 years, have enjoyed all the benefits of owning it and one day, without the building or anything changes, you own nothing. The lease has expired and the property has reverted back to the fee simple owner.

For this reason, leasehold properties tend to sell for less than “fee simple” properties, because the ownership in fee simple properties never ends. The law of supply and demand limits the prices of leasehold property. After all, if you had the choice of two properties, one where the ownership was unlimited and perpetual and one where your ownership ends on a specified date in the future with no compensation for loss of use of the property, obviously you’d pay less for the one with an expiration date.

Another thing to consider when considering leasehold property is the limitations on financing. For reasons that should be fairly obvious, a bank is not going to give you a thirty-year mortgage on a property whose lease expires in 22 years.

Another variable is that most leases have clauses in them for lease rent “renegotiation” or even statements that automatically adjust the lease rents at fixed intervals. Interestingly, the lease rents tend to go up and almost never down. Hmmm…. All joking aside, the possible lease rents increases are governed by Hawaii law and do have established ceilings. However, if someone is considering a leasehold property, its is vital that they know the current lease rents, the lease expiration and when the rent reviews/renegotiations are scheduled in the lease. These dates are fixed at the beginning of the lease and will only change if the lease is renegotiated for some reason (significant change in the property, new owners of the fee simple interest, and other factors of this kind).

One important thing to know is that, by law, any leasehold property MUST clearly state that it is leasehold property. In many advertisements, this is abbreviated to “LH” but the advertisements must make it clear that the property is not “fee simple” but “leasehold”.

As alluded to earlier, a common question is “what happens when the lease expires”. The worst-case scenario is the leasehold owner will end up with nothing. The building may be intact and everything could look perfect, but the leaseholder no longer owns anything. Of course, depending on current zoning, the owner’s plans for the property and just about any other factor you can think of, other events could occur – bulldozing and redevelopment of the property, condemnation by the county, a new lease – just about anything. Many leases contain a “right of first refusal” that give the current leaseholder the first rights to any new lease, should one be offered.

So, given these limitations, are leasehold properties out of the question to buy? Of course not. It depends on your wants and needs. Many leasehold properties are in very desirable locations (which often is why the fee-simple owner chooses to lease rather than sell – they can keep their valuable interest in the land, but still generate income from it). Its like everything else in real estate, it depends on your wants and needs. Condominiums may be right for some people and totally wrong for others. A house on several acres may be right for some and wrong for others. In the same vein – leasehold properties may be right for some and completely wrong for others.

photo credit: Claire L. Evans

Tags: Big Island, fee interest, fee simple, Hawaii, leasehold

This entry was posted on Saturday, March 8th, 2008 at 1:30 pm and is filed under Real Estate. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.