You’re browsing real estate listings when something catches your eye: a house that looks just like others in the area, but priced $100,000 less.
Then you notice the word “leasehold” on the listing. You don’t remember seeing that on other listings. Is it too good to be true? Let’s find out.
Fee simple
Fee simple ownership means “complete” ownership. It’s a legal term that means the property owner owns the land and any structures on the land, including the home. The leasehold listing that caught your eye earlier was not fee simple.
Fee simple owners can build equity over time. If their property gains value, they get to keep the profit if they decide to sell their home. But they’ll also be on the hook if they sell the property for less than they paid.
When people think of buying a home, they usually think of owning it “in fee simple.” It’s the most common type of home ownership in the U.S.
Leasehold
A leasehold is a lot different from fee simple ownership. It gives someone ownership of a home or structure on the property, but someone else owns the land itself. The leaseholder pays the fee simple owner to use the land for a set period. You might also see this called a land lease or ground lease.
Leaseholders are called lessees instead of owners since they only own the structure for so many years. Leaseholds are usually much cheaper than fee simple properties since they don’t build equity and the freeholder (fee simple owner) keeps so much control.
The idea of a leasehold property might seem strange if you’re only familiar with fee simple ownership, but it’s not that unusual in places like Hawaii, California, or New York.
So a leasehold is just a rental home?
Yes and no. When a renter leases a run-of-the-mill rental home from a landlord, they sign a lease agreement that gives them the exclusive right to live in the home for a certain number of months or years. They don’t have to “buy” anything upfront.
With a residential leasehold property, the lessee temporarily owns the structure, but it comes at a price. They have to buy the leasehold from the fee simple owner, then pay them ground rent to use the property.
Leasehold ownership gives someone more control over the home than a traditional renter. While renters usually need their landlord’s permission to make changes to the home, a leaseholder can usually remodel whenever and however they want to.
A leasehold term is typically longer than one that comes with the average rental home. Instead of 12 or 24 months, a leasehold might last 10 years, 25 years, or even longer. If the leaseholder wants to leave before then, they’ll need to find a buyer for the remainder of the contract.
All ownership returns to the original owner if and when the leasehold expires. Unless the property owner and lessee strike a deal to extend the lease or sell the property outright, the lessee walks away empty-handed. This is called reversion.
Examples of fee simple and leasehold properties
Here’s one example of fee simple ownership:
- A homeowner lists their house in Colorado Springs for $425,000. Someone submits an offer, and the owner accepts. The buyer is now the homeowner and owns the property in fee simple. That means they own the entire property, including the land and any structures on the land.
And here’s an example of a leasehold:
- A small condo in Honolulu is listed at $200,000 as a leasehold. Similar fee-simple properties are listed for around $400,000. The difference is that this leasehold only lasts for 10 years, and the lessee needs to pay the owner monthly lease rent and maintenance fees. This is different from many other condos and apartments in Honolulu and elsewhere, where tenants only pay monthly rent without an upfront fee.
Leaseholds in Hawaii
It’s no surprise that homeownership doesn’t come cheap in paradise. What might cost a few hundred thousand dollars in much of the mainland U.S. can run upwards of $1 million on the islands of Hawaii. That’s where leaseholds come in.
Leasehold ownership can give people a long-term way to live in Hawaii without the larger investment of fee simple ownership. But leaseholders will want to carefully consider the leasehold terms before signing on the dotted line.
They’ll need to pay monthly (or annual) lease fees on top of any association fees, and they won’t build equity like they would with a fee simple property.
Apartments as leaseholds
One of the biggest differences between a condo and an apartment is who owns the unit. Condos can be rented or owned, but apartments are almost always rented.
One way to buy an apartment is through a leasehold. This gives you ownership of the apartment, but not the ground it sits on. If you want to own an apartment with fee simple ownership, you’ll probably need to look at condos instead.
Fee simple interest vs. leasehold interest
Here the word “interest” is used in legal terms instead of financial terms. It’s just another way to refer to the owner’s relationship with their investment.
Fee simple interest means the owner’s interest in their property is absolute. They own it all. Leasehold interest is another term for a leasehold. The tenant’s interest comes in the form of the leased property.
Should you consider a leasehold?
Everyone has different financial situations and ownership goals, so there isn’t a one-size-fits-all answer to leasehold real estate.
Leaseholds have pros and cons. While they can offer an affordable way to own a home for a while, there are strings attached to lease rent, mortgage financing, and other aspects of the contract. Selling the leasehold can be tricky, too, especially if it doesn’t have much time left.
When in doubt, talk to a local real estate agent. They can’t make the decision for you, but they can help you crunch the numbers and clear up any confusion.
This post first appeared on Redfin.com. To see the original, click here.