FS (Fee Simple) vs. LH (Leasehold)

What is the difference between FS (Fee Simple) and LH (Leasehold)?

Fee Simple (FS): Sometimes called fee simple absolute, this is the most complete form of ownership. A fee simple buyer acquires ownership of the entire property including the land and all improvements. A fee simple owner has the right to use the land as he wishes. He may sell it, lease it, or devise it to others upon his death.

Leasehold (LH): A Leasehold interest is created when a Fee Simple land-owner enters into a contract called a ground lease with a lessee. The lessee buys Leasehold rights much as one buys Fee Simple rights; however, the Leasehold interest differs from the Fee Simple interest in several ways As the purchaser of a Leasehold property, you acquire the right to occupy and use the property for the time period stated in the lease agreement. In return, you agree to make ground rent payments (lease rent) to the lessor and abide by the terms of the lease. Lease rents typically adjust (upwards) every 10 or 15 years. At the end of the lease, the land returns to the lessor (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. And finally, the use, maintenance and alteration of the premises are all subject to any lease restrictions.
 

Why is it important to understand Leasehold?

It may affect your decision to buy.  If you are considering the purchase of a Leasehold unit, there are certain things you must know which differ from the purchase of a comparable Fee Simple unit. For example, you need to know how much time remains on the lease, how and when the ground rent payment increases are determined, and what happens to your unit at the end of the lease term.

It may affect your ability to obtain a loan. The closer you are to the end of the lease agreement, the more difficult it becomes to obtain financing. Also, lease provisions regarding matters such as the increase in lease rent may affect the willingness of some lenders to finance the property.

It may affect your ability to sell. The value of your unit could decrease as the lease approaches its expiration or rent renegotiation date.

Other Important Information

Purchasing the leased fee: Hawaii has no law that requires the lessor to sell the leased fee interest to the lessee. Still, some lessors decide voluntarily to offer the leased fee interest for sale (known as a fee conversion). If the lessor has not committed to sell the leased fee interest, you should consider the possible impact this may have on the present and future value of the property.

Surrender clause: Read the surrender clause carefully, it tells what will happen to your unit when the lease comes to an end. Most leases provide that the buildings on the land, including your unit, become the property of the lessor upon the expiration of the lease--automatically and without any payment.

Do I need expert advice?

Yes. Even after reading the lease documents and discussing them with your real estate agent, it is recommended you contact both your accountant and an attorney familiar with real estate leases. They can help you better understand how the lease and its consequences may affect you and your use of the property.