Leasehold and Fee Simple Ownership in Hawaii
A Guide to Hawaii's Residential Leasehold
Authorized by the Hawaii State Legislature and the State's Housing
Finance and Development Corporation
This article will help you understand some of the
issues involved in buying and owning residential leasehold condominium and cooperative apartments. This article uses the
term apartment unit to refer to all three forms of ownership. Anyone buying a
leasehold residential apartment should be aware of all of the consequences of
leasehold ownership.
Why is it so important for me to understand leasehold issues?
AFFECTS YOUR DECISION TO BUY.
If you were contemplating the purchase of a residential Leasehold apartment,
there are additional considerations than there are in the event that you were
contemplating the purchase of a Fee Simple apartment. For example,
you will be concerned with the length of the remaining ground lease term, what happens to
your unit at the end of the lease term, and how increases in the ground rent payments are
determined. Answers to these questions will influence your decision to buy, or not to buy.
AFFECTS YOUR ABILITY TO OBTAIN A LOAN.
As an owner of a leasehold apartment, you may some day want to refinance, or take out a second
mortgage, or use your equity for a line of credit. A short time remaining on the
fixed period or term of the ground lease could create obstacles
to obtaining the needed financing. This also could be a problem if you were seeking to
refinance either an agreement of sale or a mortgage that is soon to become due
and payable in full.
AFFECTS YOUR ABILITY TO RESELL.
If you want to sell your leasehold apartment, you could find the apartment
becomes more difficult to sell as the ground lease term approaches its rent renegotiation
and explicit expiration date. Naturally, a potential buyer would be more attracted if the
lease had a longer period until ground rent renegotiation and/or the final
expiration of the lease (see Surrender clause).
Also, ground lease provisions regarding such matters as
the increase of rent and the expiration date of the lease term may seriously
affect the willingness of some lenders to finance the proposed purchase of the
apartment unit. If, due to the short length of the ground lease term, buyers may have difficulty
obtained financing, and a seller may need to make concessions in order to sell the
apartment unit. The value of a unit could decrease as the lease term nears the expiration date.
Furthermore, real estate firms and agents may avoid taking the
property listing. Of, if they do take the listing, they may negotiate a higher
commission, and/or a bonus to the buyer's agent (paid by the seller). It also may take
longer to sell the leasehold apartment, additional expenses, and the incident of
"buyer's remorse" is more prevalent, after the buyer has had a opportunity to review
the leasehold documents, and/or the disclosure statements.
In order to understand leasehold issues, it is helpful to review some of the basic
terminology.
What does leasehold mean?
As the purchaser of leasehold property, you acquire
the right to occupy and use the leased property for the remaining time period stated in the
lease agreement. In return for this right, you agree to make ground rent payments to the
lessor and abide by the other terms of the lease.
This article is concerned with the ground lease
and with those leases related to the ground lease, such as an apartment lease.
The ground lease is a lease of land only, usually for a long term (55 years or more,
from the original date of the lease). It is a means used to separate the ownership
of the land from ownership of the buildings and other improvements constructed
on the land. In many cases, a developer enters into a master ground lease with
the fee simple owner, agreeing in the lease to construct a residential project
within a certain period of time. The developer or cooperative Corporation, or in
some cases the ground lessor, then enters into a sublease or a new lease of the land with
the apartment owner. The developer may lease the improvements to the apartment owner by
way of an apartment lease or sublease, or sells the improvements to the apartment owners
by way of a condominium conveyance or apartment deed.
The long-term ground lease should be distinguished from
the short-term rental of an apartment where, for example, a tenant rents the
apartment from a landlord for six months to a year and makes monthly rent payments.
In the latter case, the tenant receives no ownership in the land or the unit.
The tenant only enjoys the right to use the apartment during the period of the
short-term rental. In contrast, the lessee of the long-term ground lease enjoys the right
to sell the leasehold interest to a new buyer.
What is the difference between leasehold and fee simple?
FEE SIMPLE: Fee Simple ownership is
probably the most familiar form of ownership to buyers of residential property,
especially on the USA Mainland. Fee Simple is sometimes called Fee Simple Absolute,
because it is the most complete form of ownership. A fee Simple buyer acquires
ownership of the entire property, including both the land and buildings (improvements).
The Fee Simple owner does not pay ground rents, but does pay association maintenance
fees and real property taxes. The Fee Simple owner has the right to possess, use the land and
dispose of the land as he wishes--sell it, give it away, trade it for other things,
lease it to others, or pass it to others upon death.
LEASEHOLD: The leasehold interest is
created when a Fee Simple land-owner enters into an agreement or contract called a
Ground Lease with a lessee. A lessee buys leasehold rights much as one buys fee
simple rights; however, the leasehold interest differs from the Fee Simple interest
in several important respects. First, the buyer of residential leasehold property
does not own the land and must pay ground rent. Second, his use of the land is
limited to the remaining years covered by the ground lease. Thereafter, the land returns
to the lessor, and this is called 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. Finally, the use, maintenance, and alteration of the leased
premises are subject to any restrictions contained in the lease.
LEASED FEE INTEREST: After a lessor (Landlord) leases
his land to a lessee (viz. buyer), the lessor retains an interest called the Leased Fee.
In other words, once the fee owner (Landlord) leases his land to the lessee, the
lessor's rights to the land are subject to the rights of the lessee under the lease.
The lessor's rights include the right to receive ground rent payments, the right to enforce
the lease conditions such as maintenance, and the right to recover complete possession
and control of the property when the lease term expires.
Because it is so important that buyers understand the terms of the lease before
purchasing a leasehold residence, Hawaii law requires that the seller furnish the buyer
with certain information about the lease.
What information must be disclosed?
COPY OF LEASE DOCUMENTS: At a minimum, the buyer must receive a copy of the
lease document or documents which contain the major provisions of the lease. The lease
documents could be any one of the following:
- The master lease and any amendments; or
- The apartment lease and any amendments; or
- For buyers of new condominium apartments, a copy of the condominium public report.
In addition to the minimum legal requirement, buyers should review other relevant lease
Document. For example, the buyer of a cooperative apartment may want to review the master
lease in addition to the proprietary lease on the apartment.
RECEIPT OR CONTRACT: The buyer must sign a receipt or a copy of the sales
contract to acknowledge receiving the lease documents. The receipt or contract must also
include a summary of the major provisions of the lease in plain language, lease rent
renegotiation dates, how renegotiated lease rents will be calculated, and surrender clause
provisions. Normally this will be accomplished in a separate addendum attached to the
contract or receipt. Buyers also must be informed that current law does not give
condominium and cooperative lessees (buyers) the right to require that the lessors sells them the
leased fee interest in the land under their apartments. Finally, the buyer needs to
acknowledge that he or she has read and understands the terms of the lease documents.
Who must disclose this information?
It is the responsibility of the seller to furnish
the buyer with a copy of the lease documents and other information about the lease.
The seller may provide the information directly or through an agent, most likely the
seller's real estate agent. Copies of the recorded lease and amendments are available
at the Bureau of Conveyances public record office in Honolulu.
When must leasehold information be disclosed?
The seller or seller's agent must provide the required
information to the buyer within 10 days from acceptance of the sales contract
(that is, no later than 10 days from the date the buyer and seller reached a final
agreement for sale of the property).
What information about the lease should the buyer understand?
As a buyer, you should read the lease carefully
and be sure you understand its terms and conditions and how they affect you and
relate to your plans and goals. The best time to do this is before you make an
offer to purchase your leasehold apartment unit. To obtain a copy of the lease,
ask the seller, the seller's agent, or your own adviser.
Note: in reality, the Seller, or the Seller's agent
typically does not provide the lease documents "prior" to your making an offer to
purchase the leasehold apartment. If that is the case, ask your agent, or representative
to provide a Leasehold Disclosure Statement outlining the known facts about the project,
the ground lease: fixed periods, renegotiation dates, expiration date, and the surrender clause.
Then, when reviewing the Ground Lease, within those days as
noted on the Purchase Contract, it is especially important to find out the following information:
LEASE TERM: Find out the length of the lease, how many years are remaining until
the lease ends, and whether their is any right to extent.
LEASE RENT: Be sure you understand how much
lease rent you will have to pay (which often includes Hawaii general excise tax), when it
is payable and to whom, and what penalties are prescribed for late payment. Lease rents
typically adjust every 10 years, for the next 10 years, after the first "fixed period(s)".
Find out when the rent adjusts, and to what amount. Also find out whether or not
your maintenance fee payments include the ground lease rent.
LEASE RENT RENEGOTIATION DATES: At some
point the lease rent may adjust (increase), but to an amount which will be renegotiated at that
time. Know when the lease rent payments are scheduled to be renegotiated. The ground lease
likely contains more than one renegotiation date, such as every 10 years.
CALCULATION OF NEW LEASE RENT: Understand
how the new rent payments will be determined upon renegotiation, including any
procedures involving the use of arbitration. The master lease often contains a formula
for calculating the new lease rent. This formal is generally based on a percentage
of the market value of the unencumbered fee simple land value existing at the time of
renegotiation. If market value increases significantly, so will your future lease rent.
SURRENDER CLAUSE: Read the surrender clause
carefully. It tells you what will happen to your apartment unit when the master lease
comes to an end (expiration date). Most leases provide that the buildings on the land including
your apartment, and all its improvements, become the property of the lessor (Landlord)
upon the expiration of the term of the lease--automatically and without any payment.
AMENDMENTS TO MASTER LEASE: Leases are sometimes
amended to reflect a change in the lease terms or an extension of the term of
the lease. The best way to tell if their have been amendments is to examine a
recent title report on the property prepared by a licensed title company.
Questions to ask before you buy leasehold property
- How long is the lease term?
- When is the expiration date, and is there an extension
clause?
- How much is the lease rent?
- When are the lease rent renegotiation dates?
- How will the new lease rent be determined?
- What are the terms of the surrender clause?
What is the buyer's right to cancel the contract (Purchase Contract)?
The law also provides that, within five days of
acknowledging receipt of the lease documents, the buyer has the right to cancel
the contract and recover all deposit money. The seller and buyer may agree in
writing to reduce or extent the time period required for the seller to provide
the lease documents and the buyer to review them.
What is the role of the leasehold addendum at the time of signing the sales contract
(Purchase Contract)?
Your Standard Sales Contract (also called the Deposit
Receipt, Offer and Acceptance or Purchase Contract) may contain a detailed addendum that
informs you about ground leases in general and specifically about your own ground lease.
Ask the sales agent for a copy of any standard leasehold addendum so that you
can review it in advance of your making an offer. Be sure to ask questions if
you do not understand any part of the addendum.
Do I need expert advice?
If, after reading the lease Document and the
summary of its major provisions provided by the seller, and discussing this
with your real estate agent, you still have questions about the lease, you
should see an attorney familiar with real estate ground leases. The attorney can help
you understand how the lease and its consequences affects you and your use of
the property.
When you acquire a unit in a cooperative, you
receive a proprietary lease. If the sale is a cash sale, you will receive a share
of stock in the co-op corporation. If the sale is financed, either by the seller
or a mortgage firm, you will receive a share of stock upon satisfaction of the debt.
When a leasehold apartment unit in a condominium or a PUD is originally conveyed,
this is done by an apartment lease. Upon resale, that lease will be transferred
by an Assignment of Lease. The heading on the original apartment lease may have
one of several descriptions: Apartment Lease, Apartment Lease and Ground Lease,
Condominium Conveyance Document, Apartment Deed and Ground Lease, or Dwelling Lease.
Regardless of the type, the consequences of your leasehold ownership will be
substantially similar to those described in this article.
What are the typical provisions of an apartment lease?
The written lease spells out all the terms,
conditions, and restrictions binding on the lessee, and all subsequent assignees
or successor lessees. These terms generally are not negotiable. For example,
the lease includes such items as the total number of years in the lease term,
the rent (both fixed and renegotiated), termination or renewal dates, conditions
of possession and use, and rights regarding the lessee's ability to make, and to
later remove, improvements. Some of the more common provisions of residential
apartment unit leases are the following:
LEASE TERM: The length of the term of an
apartment unit ground lease may be for whatever the original lessor and lessees
agreed upon; however, the typical length is at least 50 years, and usually is
within a range of between 55 and 75 years.
How much ground lease rent must I pay?
LEASE RENT: Typically, the rent will be
fixed for the early years of the lease term and afterward will be renegotiated
periodically.
FIXED RENT: Most leases have a fixed rent
period of between 25 and 35 years. During this period the rent is fixed or
predetermined. Their may be one or more step up increments during the fixed rent.
You know exactly how much your lease rent payments will be.
RENEGOTIATED RENT: At the end of the fixed
rent period, the lease rent is renegotiated, or adjusted. This is sometimes
referred to as "reopening". When you purchase your leasehold apartment unit, it
is very important to realize that you don't usually know the exact amount of
rent you will have to pay over the entire life of the lease. As you can imagine,
this is important factor for both you and your lender to consider as your ability
to pay monthly mortgage payments may be directly affected by changes to the lease
rent payments. This is because the renegotiated rent is generally based on a certain
rate of return on the value of the unencumbered fee simple land value in the future
(at the time of renegotiation).
What are other provisions I should be aware of?
ASSIGNMENTS OF THE LEASE: The transfer of
a leasehold interest is accomplished by a document called an "assignment". When
you sell your leasehold apartment unit to a new buyer, you assign the lease to
the buyer, (also called the assignee). Your lease may require the consent of
the lessor prior to any assignment of the lease. Courts have held, however,
that the lessor may not unreasonably withhold consent. Even after an assignment,
you may remain responsible under the lease unless the lessor releases you and
agrees to allow the buyer to assume all the responsibilities of the lessee.
PUBLIC CONDEMNATION: Occasionally all or
a portion of the leased property is taken by a government authority for a public
purpose such as road widening or sewer installation. When condemnation occurs,
the lease specifics what happens to your apartment unit and how you are compensated
for loss of your leasehold interest. Read your lease carefully.
What happens to my unit at the end of the lease?
SURRENDER: The surrender clause provides
what happens to the apartment unit and other improvements when the lease expires.
At the end of the lease term the lessee must surrender or deliver to the lessor
possession of the land. What happens to the apartment units and other improvements
on the land depends on the language of the surrender clause. Be sure to read
the surrender clause carefully. Most surrender clauses can be divided into three types:
APARTMENT UNIT TO LESSOR: The first type
of surrender clause gives the apartment units and common elements to the lessor
upon expiration of the lease. If the lessor desires to remove the apartment unit,
or the whole building, the lessor is responsible for any costs involved in
demolition and removal.
APARTMENT UNIT TO LESSEE: The second type
of surrender clause gives the apartment unit to the lessee. However, because
the lessee must return the land to the lessor in its original condition when
the lease ends, the lessee is responsible for the proportionate costs of the
demolition and removal of the apartment unit. This could be a disadvantage to
lessees if they must pay for the demolition and removal. If the building is
still in good condition or can be refurbished, the lessor may be willing to
purchase the apartment units and improvements from the lessees. Note: This arrangement
if NOT common, and you should read this document very carefully.
LESSOR PURCHASES APARTMENT UNIT: The third,
and least common type of surrender clause is one where the lessor and lessee
have agreed on a price the lessor will pay for the apartment unit and its share
of the common elements upon expiration of the lease, or earlier. This may happen
if the lessor has an opportunity to re-develop the land, with a larger building,
with many additional apartment units.
What other obligations do I have?
EVENTS OF DEFAULT: The lessee incurs many
obligations under the lease such as maintaining the building, paying real
property taxes and ground lease rent, and maintaining insurance. Failure to abide by
the terms of the lease, including failing to pay real property tax and lease
rent and maintenance fees could result in money damages or even termination of
your lease.
MAINTENANCE AND INSURANCE: The lessee is
usually held responsible for the maintenance and upkeep of the property,
including paying all real property taxes and assessments, insuring the
apartment against loss or damages by fire, and for maintaining public liability
insurance.
TERMINATION: The lease terminates on the
expiration date specified in the master lease agreement. A lease may also be terminated
by mutual agreement of the lessee and lessor, or by eviction because of a breach
of a lease provision.
Unless you have the cash to pay the full price
to buy your apartment unit, you will need to obtain a loan to finance the
difference between the cash down payment and the sales price. The terms of the
lease can affect your ability to obtain a loan, especially if the lease is due
to expire in less than 30 years, or if there are only a few years remaining on
the fixed rent period.
How do the lease terms affects my ability to obtain financing?
Most banks and other lending institutions have
policies for approving loans on leasehold property that can affect a buyer's
ability to finance, or refinance, and an owner's subsequent ability to resell.
Certain lenders require that there be at least 7-10 years remaining on the
fixed rental portion of the lease, or that the term of the lender's loan be no
longer than the remaining number of years on the lease, less two years.
In addition, the Veterans Administration will
not guarantee a mortgage beyond the actual time remaining on the fixed rent
period of the lease, and the Federal Housing Administration insurers mortgages
only up to 5 years beyond the fixed rent period of the lease.
These policies may make it more difficult for an
apartment unit owner to sell the unit as the fixed rent period or the entire
lease term shortens. Lenders are cautious about lending money against leases
with short fixed rent period because they are concerned that the borrower may
not be able to make the monthly mortgage payment if the renegotiated lease rent
increases substantially.
What are the lessee's options when the lease term is less than the loan term?
If you are considering purchasing a leasehold
apartment unit and only a few years remain on the fixed rent period of the lease,
it may be helpful to contacts an appraiser to estimate approximately what the
lease rent would be if renegotiated at this time.
SHORTER LOAN TERM: The buyer could apply
to a conventional lender for a loan with a shorter term.
OWNER FINANCING: The lessee-seller may be
willing to finance the purchase through an agreement of sale or mortgage,
with the seller in essence acting as the lender. For this to happen, you may need
a larger downpayment, a higher interest rate, and a shorter time frame.
EXTENDING THE LEASE: The lessee can inquire
whether the lessor is willing to extend the lease term.
PURCHASE THE FEE: Finally, the lessee can
inquire whether it is possible to purchase the leased fee interest from the lessor.
The lessor may decide to make a voluntary sale of the leased fee interest to
some or all of the apartment unit owners in the project, but the lessor is under
no obligation to do so.
As we have already seen, in most leases, the rent
is not fixed, or predetermined, for the full term of the lease. Rather, at certain
dates (called renegotiation dates), the lessor and lessee must agree on a new
lease rent. Lease rent renegotiations are usually scheduled in 10 to 15 year
intervals after the initial fixed rent period (usually 25 to 30 years). The
majority of leasehold apartment units in the State of Hawaii are due to renegotiate
lease rents between the years 1990 and 2019.
Most leases contain a formula for determining
the new lease rent. Because the formula is frequently based on rent and market
conditions existing on the renegotiation dates, the rent could rise dramatically
and is not known with certainty until the actual time of renegotiation. As a buyer,
it is important to read the lease documents carefully so that you understand when
and how the new lease rent payments will be calculated upon renegotiation.
Most general leases provide a formula for the
renegotiated rents to be based on a stated rate of return on the market value
of the land under the project at the time of rent renegotiation. For example,
if at the time of renegotiation, the value of the land under a 100-unit condominium
is $5,000,000 and the stated rate of return is 7%, then the formula would result
in a renegotiated rent of $3,500 per year or $291 per month ($5,000,000 X 7% X 1%,
assuming your unit represented a 1% common interest in the land).
In other cases, the rate of return is an amount
to be renegotiated based on current land value and current rates of return.
Two other less common methods for determining renegotiation rent are 1) Basing
the new rent on current market rent for similar buildings; and 2) Increasing
the current rent by the change in the consumer price index over the preceding
fixed rent period.
Under all but the last method, leases generally
provide that if the lessee and lessor cannot agree on the new lease rent before
the beginning of the renegotiated rent period, the rent will be determined by
an arbitration procedure. For example, the lease may specify that the market
value of the land will be decided by three impartial real estate appraisers,
one to be chosen by the lessee, one by the lessor, and the third selected by the
first two. In deciding the market value, the land is usually treated as though
it had no structures on it.
After the market value of the land is determined,
it is multiplied by a percentage rate of return specified in the lease (or, if
not, then determined by the appraisers) to compute the rent for the entire
apartment unit project. Then this figure is multiplied by the lessee's percentage
share in the common interest in the project to determine the amount of the lessee's
individual rent.
Many leases have the rate of return set at a
specific rate. Other leases may provide that the rate be based on the prevailing
rate of return for similar properties at the time of renegotiation. The prevailing
rate of return for similar properties will depend on market conditions existing
at the time of renegotiation.
As you can see, this method of calculating renegotiated
lease rent is tied closely to current land value. Since there is no upper limit
on land value other than current market conditions, the new rent may increase
greatly. This increase will reflect the rise in land values since the beginning
of the lease 25 to 35 years ago.
What is mandatory arbitration?
Hawaii law provides that all ground leases for
condominium and cooperative projects must contain a provision for the mandatory
arbitration of any renegotiated rent. This means that if the lessee and the
lessor cannot agree on a new rent before the renegotiation date, either may
request that the rent be decided by an impartial party. For example, this
impartial party would include a panel of real estate appraisers.
If the lease does not provide for the arbitration
of lease rent and if the parties are unable to agree on the rent upon renegotiation,
than the law specifies the process to follow. The law does not, however, specify
or limit the amount or rate of rent to be paid. Here is the required procedure:
- The new rent shall be determined by three impartial
arbitrators who are recognized real estate appraisers.
- The lessee and lessor will each select one appraiser.
The first two appraisers will select the third.
- The three appraisers will determine the renegotiated
rent and their decision will be final and binding.
- The lessee and lessor will share the costs equally.
What are the lease rent renegotiation formulas for cooperatives?
Hawaii law provides a ceiling for renegotiated
rent for cooperative apartment projects that qualify under the law. This law
does not apply to rent renegotiation of units in condominium and PUD projects.
The law applies to all cooperative proprietary
leases which call for rent renegotiation. It provides that renegotiation of
rent cannot take place more than once every 10 years and the first renegotiation
can be no sooner than 15 years following the commencement date of the lease.
It also provides a formula for determining the maximum amount of renegotiated
lease rent to be paid by the cooperative housing corporation.
If the lessee corporation and the lessor cannot
come to an agreement on the new lease rent, the law requires that the rent be
determined by an impartial Third Party through arbitration proceedings conducted
by the State Housing Finance and Development Corp.
Several possibilities exist at the expiration of
the lease term, and most leases contain a reversion and surrender clause.
REVERSION: The typical apartment lease
provides that the land reverts to the lessor at the end of the lease term.
In other words, when the lease expires, the lessor retakes possession of the land.
When you buy an apartment unit on leased land, it is important to consider what
happens to the unit after the lease expires.
SURRENDER CLAUSE: Apartment unit leases
typically contain a surrender clause providing that, upon expiration of the
lease, the land, all apartment units, and other improvements become the
property of the lessor. The clause generally requires that the lessee surrender
to the lessor, upon expiration of the lease term, all apartment units, garages,
roads, landscaping, and swimming pools, even if these improvements where built
and maintained at the lessee's expense.
What are the different possibilities that occur at the expiration of the lease?
ATTEMPT TO NEGOTIATE AN EXTENSION OR NEW LEASE:
The lessee could attempt to negotiate a new ground lease or extend the ground
lease even though the lessor may not be legally obligated to do so. The lessor
may be unwilling to extend or enter into a new lease if the lessor has plans
to redevelop the property. On the other hand, a lessor who plans to maintain
the project as a residential property may be willing to grant a new lease.
In this situation, however, the new lease rent could be the market rental price
of the land and the apartment unit, as both became the property of the lessor
at expiration of the original lease.
SURRENDER IMPROVEMENTS TO LESSOR: If the
lessee is unable to negotiate an extension of the existing lease or a new lease,
the lessee may be forced to surrender the apartment unit to the lessor and move out.
REMOVAL OF IMPROVEMENTS: The surrender
clause may instead require the apartment lessees to remove the structure
and restore the leased land to its original condition at the end of the lease
term. In the case of a condominium or cooperative, the initial apartment owner
would be legally required to pay his or her proportionate share of the expense
of removal of the building that contains the apartment unit when the lease expires.
Hawaii does not have a law requiring the lessor
to sell to the lessee the leased fee interest under a condominium, cooperative
or PUD leasehold project. Still, some lessors decide voluntarily to offer for
sale the leased fee interest to apartment owners (referred to as a fee conversion).
How is the offering price determined?
The price at which the fee may be offered is not
subject to any legal restrictions. This price may be determined by mutual agreement
between the parties or set by an impartial panel of one or more appraisers.
In some cases, the lessor may want a certain price, leaving little room for
negotiation.
Appraisers typically use the income approach to
value the leased fee interest in the land under a leased apartment unit.
In addition to lease rent payable over the period of the lease, the owner also
will receive the return of the land at the end of the lease (reversion).
The appraiser calculates the amount of lease rent
due over the fixed period of the lease and estimates the projected rent over
the renegotiated lease period. This amount is then reduced (discounted) using
present value tables. This reflects the fact that lease rent dollars received
in the future are worth less than dollars received today. In essence, the appraiser
asks how much would a person need to invest today (as in an annuity) to receive
a stream of income equal to the amount of rent projected for the entire lease term.
Next, the appraiser evaluate the worth of the revision
of the land, by calculating the projected value of the land at the end of the
lease but then discounting that amount to present value. An example follows:
Determining the value of leased fee
Projected ground rent over remaining lease term
(discounted to present worth):
Present value of fixed rent $600,000
Present value of renegotiated rent $900,000
Plus
Present value of reversionary interest in land (market value of raw land discounted to
present worth): $500,000
Equals
$2, 000,000
Times
Lessee's percentage of common interest X 1%
Value of leased fee interest $20,000
As you can see, it is not easy to determine what
price you may have to pay for the leased fee interest, assuming the lessor is
willing to sell, and you are willing to buy. If the lessor does offer to sell
the leased fee interest, you may want to consult an expert to advice you about
the pros and cons of the offer. If the lessor has not committed to sell the
leased fee interest, you should carefully consider the possible impact of this
on present and future values.
Sometimes preliminary negotiations for the voluntary
sale of the leased fee are underway when the sellers list their apartment unit
for sale. One of the questions you as a buyer want to ask the seller is whether
there is an ongoing or planned leased/fee conversion. If so, the sales contract
(Purchase Contract) should address such issues as seller cooperation and transfer of any
deposit money.
What is the right of first refusal for condominium associations and cooperative
corporations?
In 1988, the Hawaii State Legislature enacted a
law to give condominium owners' associations a right of first refusal to buy the
leased fee interest if the lessor decides to sell to anyone other than the existing
individual apartment owners. At least 75% of the unit lessees must approve of the
purchase, or the lessor can complete his sale of the fee to another party. The
intent of this law is to encourage negotiation for a leased fee sale between
lessors and condominium or cooperative owners or their associations or corporations.
As described in this article, leasehold ownership
of apartment units involves a unique relationship and agreement between the
parties to the apartment lease. Everyone considering the purchase of a leasehold
apartment unit needs to understand the advantages and disadvantages of leasehold
ownership in general, especially the impact of rent renegotiation and lease expiration.
Reading this article is one step in that process.
The next step is to obtain and carefully read the applicable lease documents.
Then if you have questions or need professional advice about the terms or
implications of that lease, address your questions to the seller or to the seller's
agent, the lessor, and to your real estate agent and attorney.
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INTRODUCTION