Leasehold vs. Fee Simple Ownership: FAQs

Posted by Courtney Brown on Thursday, January 18th, 2018 at 1:34pm.

Frequently Asked Questions: What is the difference between Leasehold and Fee Simple Ownership in Hawaii

Alaeloa Maui Leasehold

Alaeloa: a rare gem, oceanfront and ocean view cottages in Napili, Maui

Why is there leasehold property? The History of Leasehold Property in West Maui:

With the development of the Kaanapali Resort in 1961 and later the Kapalua Resort in 1978, Maui became a vacation destination. As tourism flourished and became the mainstay of our economy, local landowners partnered with developers to build Leasehold condominiums on family-owned properties or on former agricultural land.  In West Maui, many local landowners saw this as a way to retain ownership of their land and derive income from the lease rents.  Leases were typically set for 99 years, with renegotiations after a set period of time, and then every 10 years until expiration.

In Kapalua, the Ironwoods, Golf Villas, Bay Villas and Ridge Villas all started as leasehold properties and converted to Fee Simple ownership.  In Kaanapali, the Kaanapali Alii, Whalerand Kaanapali Royal started as Leasehold and the fee was offered for sale, though not everyone elected to purchase it at the time of the offering--at these condominium properties, you'll find both Fee Simple and Leasehold condominiums for sale.  The Maui Eldorado remains Leasehold.  Napili also has its share of leasehold development, though, like Kapalua, most all have converted to fee simple.  Currently, at Napili Point Phase I condominiums are Leasehold and Phase II condominiums are Fee Simple.

What does Leasehold and Fee Simple Ownership mean?

Hawaii is one of a handful of states in America that has both Fee Simple and Leasehold ownership.  Our MLS notes whether a property is being offered in Fee Simple (FS), Leasehold (LH), or Leasehold-FA (Fee Simple interest available for separate purchase).

Fee simple ownership, which is what is typically offered in the mainland US, is ownership of the land and all improvements. In the case of a condominium property, Fee Simple ownership is the ownership of the condominium unit and ownership of a percentage interest of the common elements and limited common elements.

A Leasehold interest is outlined in a Master Lease which outlines the length and terms of the lease between the land owner (the Lessor) and the buyer of the property (Lessee), who acquires an interest in the property with the right to occupy and use the leased property for a specified period of time.  The Lessee does not own the land, and pays rent for the land per the terms of the master lease.

At the end of the lease, there is typically a surrender clause, whereby ownership of any improvements on the land revert back to the Lessor. Prior to the expiration of the master lease, it is possible, but not guaranteed, that a Lessor and Lessee may renegotiate and extend the lease agreement.  If the Lessor chooses to sell the Fee Simple interest, the Leasehold owner (or Association of Apartment Owners) is offered the first opportunity to buy it.

What are common definitions* owning a leasehold property?

When purchasing a leasehold property, a Leasehold Disclosure is required which provides the buyer the opportunity to review and approve the Leasehold Documents, including the Master Lease and any amendments.  Definitions follow:

  • Leasehold Property: A Property held under the terms of a Lease agreement. The holder of a Leasehold Interest, Lessee, usually pays the owner of the Leased Fee Interest, Lessor, a stated amount of Lease rent over a specified Lease term in consideration for the right to use and occupy the Property.
  • Lease: The written agreement between a Fee Simple owner, Lessor, giving possession of the land or another person, Lessee, for a definite period of time in return for the payment of rent.
  • Lease Term: length of the lease.
  • Fixed Period: leases rents are set for a period of time.
  • Renegotiation Dates: the date on which the terms of the Lease are renegotiated and changed. In most Leases the Lease rent is not
    fixed for the full term of the Lease; instead, at certain fixed times stated in the Lease, called Renegotiation Date(s), Lessor and Lessee agree on a new Lease rent. The Lease may contain a formula for setting the new Lease rent and any increases.
  • Expiration Date: date on which the Lease ends and Lessee is obligated to return the land to Lessor unless there are other stipulations in the Lease. There is no obligation for Lessor to negotiate a new Lease with Lessee after the Expiration of the Lease.
  • Surrender Clause: Provision(s) in the Lease which mandate(s) that AT THE END OF THE LEASE, the Lessee has to surrender the
    Property and the land back to the Lessor. Some provisions in the Surrender Clause include the stipulation as to who receives any
    improvements and what conditions apply. The conditions spelled out in the Surrender Clause of the Lease, provide if the Lessor keeps the improvements or if Lessee is obligated to remove the improvements or face Lessor’s costs for doing so, or if Lessee has the right to remove the improvements in a certain timely manner. Hawaii law may limit or even change Lessor’s rights under the Lease.

Leasehold Example: Alaeloa

Alaeloa is a highly desirable condominium community located in Napili.  The Alaeloa Leasehold estate was created in 1965 and originally was set to expire in 2024, with ground lease rents determined every ten years by the appraised value of the property as if it were unencumbered and there were no improvements.  The ground rents are determined by the agreed upon appraised value times a specified interest rate or the then prevailing rate of similar properties that are similarly located.   

In 2010, the AOAO and the Fee Owners reached an agreement, whereby the lease was extended to December 31, 2059.  Yearly lease rents were established through 2019 and renegotiations in 2020, 2025, 2035, and 2045.

Considerations when evaluating Leasehold vs. Fee Simple ownership

There are both pros and cons involved in Leasehold ownership. 

  • A Leasehold property may be more affordable than a Fee Simple Property of a similar size/location.  It may also allow you to own in a very unique location (like Alaeloa).
  • When there is less than 35 years left on the lease, most lenders will not approve a 30 year conventional mortgage, meaning that buyers may need to either pay cash or finance with a 15 year mortgage). 
  • With 30 years or less remaining on the lease, the property will not qualify for a 1031 tax-deferred exchange.
  • Lease rents renegotiate, so an owner of a leasehold property does need to be aware that their monthly lease rents could increase with each renegotiation.
  • Lease rents are separate from condominium maintenance fees, which typically cover maintenance of the common element and the reserve funds for repairs to the common element.
  • Property taxes are the responsibility of the Lessee
  • The Lessor is under no obligation to renegotiate or extend the lease or sell the Fee Simple Interest.

Who should I consult regarding the implications of owning a leasehold property?

This article is an overview of some of the differences between types of ownership and not intended as legal or tax advice. When purchasing either a leasehold or fee simple property, it is advised to consult with your CPA, Financial Advisors, and Legal Professionals to determine what implications there are for you personally.

Resources

Courtney M. Brown, R(S)
Vice President
Island Sotheby's International Realty

 

Leave a Comment