Most people know the difference between renting and owning a home, but there’s a third category many aren’t familiar with, called a leasehold property. That’s where you lease (or rent) property, but for far longer than a tenant’s usual one- or two-year time frame.
Contracts for leaseholds, in contrast, last for a minimum of 40 years—up to 120! Yeah, that’s a long, long time, almost certainly far past the point that you’ll get to enjoy the place. So what’s the deal with this long-haul lease?
Read on for details, and to figure out whether a leasehold might be the right property for you. (The Brits call this type of property arrangement a freehold).
How a leasehold property works
In leasehold or freehold arrangements, the property owner (also called the freeholder) grants the leaseholder the right to live on the property for a specified span of time. To hold up his end of the bargain, the lessee will have to make a down payment—only it’s far less than the typical 20% required on a conventional home.
After that, the leaseholder pays rent (it’s sometimes called ground rent) every month, like your typical tenant.
Since leaseholders commit to renting a property for such a long span of time, they have one clear advantage over more temporary tenants in that they can have their way with home improvements.
Leaseholders can renovate to their heart’s content, build additions, or even erect whole new buildings on the land (and rent those units out to tenants of their own choosing).
At the end of the lease, however, unless the contract stipulates otherwise or a longer lease is negotiated, the property or land reverts back to the owner, improvements and all.
While properties with leaseholds are fairly rare, this type of property can still be found across the United States, particularly in New York, Florida, and Hawaii.
Leaseholds make particular sense on islands or beach communities, where land is limited and at a premium.
In Maui, for example, leasehold or freehold estates were more commonly created in condo developments during the 1970s and 1980s (and many of them are at the point of running out).
Benefits of a leasehold property
Leasehold properties come with a few noteworthy benefits for the potential owner. For one, they’re usually less expensive than purchasing the same land outright.
You can also sell your leasehold to someone else without the property owner’s permission or involvement; the more time left on the lease, the more valuable it is.
“For most home buyers, leasehold property is a bad option, because you really don’t build equity,” Berger explains. “Mention ‘leasehold property’ ownership to most Hawaii residents, and you’re likely to be met with stern warnings.”
“The cost of owning the unit is low, and the rental income it produces can generate a good return on the ground rent over the long haul of the lease,” he says.
Leasehold interests are also good for seniors on a fixed income. Under a short-term lease, the rent can be raised every year. But with a leasehold interest, the rates could stay the same for decades.
With a lower down payment than a freehold property would require, becoming a freeholder could be the ideal arrangement for older people looking to downsize.
But for some people, this leasehold gray area between renting and buying could be the perfect ticket to kicking back on a patch of paradise without the hassles that true homeownership often entails.
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