Fee Simple vs. Leasehold Investment Properties in Hawaii

Realtors use a lot of big words. They sound impressive in a real-estate contract, and they make us feel important when we talk about our work around the water cooler. They’re useful shorthand for us, too, allowing us to quickly and efficiently discuss the terms of a listing without having to hash out every niggling little detail.

Occasionally, however, a new term comes up that just smacks us right in the face and makes us go ‘what in the world are you talking about?’ I had that experience a while back when I moved to the Big Island of Hawaii and came across the term ‘leasehold’. I’d never encountered it before, but goodness if I haven’t encountered it quite a bit since.

A ‘leasehold’ is, in essence, a long-term rental contract, very similar in form to the lease a business might sign for its offices or showroom. Only in this case, it’s been applied to a residential property–typically a condo or apartment, although it isn’t uncommon to see a farm property or ranch house marketed as a leasehold property as well. And leasehold properties in general are quite common in Hawaii. So common, in fact, that I decided the topic needs to be explored a bit more in depth so that when you come across it in your own search for investment properties, you’ll be more prepared than I was to understand what you’re dealing with.

— The problems with leaseholds —

I can’t really structure this as a straight ‘pros and cons’ article because, in my opinion, there are very few points in the ‘pro’ column and a whole host of them on the ‘con’ side. Most of the things you look for in a good investment property–such as the fact that property generally appreciates in value–just do not exist in a leasehold agreement.

The thing of it is, a leasehold is in essence a long-term rental contract. Unlike rental contracts, however, you do technically ‘own’ the property for the length of the lease term. You can make improvements and structural changes, even to the point of gutting the structure completely (not advised). But you cannot re-sell the property, and eventually the lease will expire and you will be forced to surrender the property back to the owner.

So from an investment standpoint, the only return you will ever see on your investment is if and when you sub-let the property out to a third party. Renting out your rental, so to speak. This is in sharp contrast to a property which you purchase through a fee simple transaction as even if you choose not to rent that property out, the value will generally still rise over time.

In point of fact, the value of the leasehold generally DEPRECIATES over time, in that the closer you are to the end of the lease, the less investment opportunity you have, and therefore the smaller your return on investment can be.

Another point to consider before entering into a leasehold agreement is that the party from whom you lease the property is under no compunction to renew the lease after it expires. Now, to be fair, usually the lease can be extended after it expires, but not always, and not always with the same terms. And since you do not own the property, you have no legal standing for appeal if they decide to deny you an extension and kick you out. You’ll usually see it coming–leasehold renewal negotiations often occur years before the term expires–but if no agreement can be reached, then the leasehold will expire and you will be forced to relinquish the property.

— The Benefits of a Leasehold —

So the leasehold doesn’t gain in value over time, it has limited return on investment potential, and you might find yourself kicked out of the property if the lease isn’t extended. ‘Tom’, I can hear you asking, ‘why in the world would I ever be interested in a leasehold as an investment property?’

I’m glad you asked.

You see, there IS a reason to invest in a leasehold property. They typically cost much, much less to acquire than a fee simple property would. Which shouldn’t be surprising; since you’re essentially renting the property, of course the price will be lower than if you were buying. But the lower barrier to entry does stand as a potential benefit; less money needed to get into the property means less time before it potentially starts turning a profit for you.

I also had a client a while back who specifically requested a leasehold property because of their age; the client was of advanced years and didn’t mind the idea of the leasehold because–not to put too fine a point on it–they didn’t believe they’d be around to see the end of the lease. They saw it as a way to upgrade their living conditions without having to spend as much money as they would if they’d purchased the property outright. I can’t deny that such things can be a consideration when getting into leasehold properties, but I don’t generally recommend them as primary motivators.

— The Conclusion —

You can probably guess where I fall on the issue of leasehold investment properties by this point. I don’t think they’re a good idea, and I always advise my clients to steer clear of them unless they have a unique set of circumstances. Whether it’s the fact that you don’t own the land, the fact that there’s much more limited opportunities for return on investment, or even the fact that you’ll never be sure whether or not you’ll even be renewed from term to term, it just strikes me as a poor investment opportunity all the way around.

So that’s my advice to you; stay far away from leasehold properties. Beware condos that are listed at well below market value, or beach houses that have prices that seem too good to be true. These are often leasehold properties, and as the old saying goes; things that seem too good to be true generally are.”