Buyer Guide – Leasehold vs Freehold
Leasehold vs Freehold. What you need to know about buying or selling Leasehold Properties (Part 1 of 2: Leasehold Series)
Author: Meryl Hamdillah, REALTOR with Sutton WestCoast Group.
If you are looking for a realtor to help you buy or sell a property in Coquitlam or Vancouver, feel free to Chat with me now! 604-307-9506
Comparing Leasehold vs Freehold?
For those of you unfamiliar with the term “leasehold”, it’s not a big surprise considering that there are not as many leasehold properties available on the market as there are freehold properties across the lower mainland. However, there are significant factors that make leaseholds attractive; Leaseholds are priced significantly lower than freehold properties; They are are often located in prime neighborhoods like False Creek, UBC, SFU and parts of Richmond. These are increasingly determinant factors and many clients who love these neighborhoods consider ownership without having seen a leasehold agreement before. We decided that it’s worth taking the time to share the key questions and issues that come up surrounding leaseholds in this series of blogs.
WHAT IS A LEASEHOLD?
As the name suggest, the leasehold implies that the Purchaser of a leasehold is buying into the terms of an agreement between the Landlord (e.g. City of Vancouver) and the Lessee (e.g. the “Purchaser”). This “Ground Lease” or “Head Lease” contains all the required information that you as a purchaser would need to know as a Lessee and is one of key documents that your Realtor is expected to request on your behalf.
While leasehold properties is a method of “ownership”, it’s important to know that as a purchaser, you do not own the land that the property sits on but have the “right to use” the property ( at least until the end of the lease term) Why is this important? Unlike a Freehold property, which we will describe later, the owner of the land ( also known as the landlord) has the right to sell or increase the rent on the land at the end of the term unless otherwise indicated in the lease. Due to the uncertainty of this type of ownership, some people are hesitant to purchase a leasehold especially when the lease is close to the end of its term. The maximum term being 99 years.
WHAT IS A FREEHOLD?
A Freehold property is one where the purchaser legally owns both the property and the land in which the property sits on in perpetuity ( or at least until you pass away or sell or transfer your rights to another). A person who owns a freehold property is considered to be the true owner of the property as there is no landlord to sell or increase rent on the land unlike a Leasehold property. Many investors prefer freehold properties over leasehold properties because the appreciation value of a freehold typically appreciates more compared to a leasehold over time. The simple fact is land typically appreciates more than the building (which tends to depreciate). In the case of a leasehold, you only own your unit and the right to use the land. As a result, the price tag of a freehold property is significantly higher than that of a leasehold to reflect the difference in land ownership.
WHY DO PEOPLE BUY LEASEHOLD vs FREEHOLD?
If people don’t own the land that the property sits on, you may ask “Why would people buy leaseholds?” The answer to this question is not much different than asking “why do people lease vehicles (versus buying a vehicle outright)? Just like buying a vehicle (whether it may be upfront or in the form of a lease), the decision to buy a leasehold property (versus a freehold) depends on the purchasers’ financing ability as well as their needs and motivations. For instance, the financing ability of someone who earns $40,000 per year may not necessarily be able to mortgage a one bedroom “freehold” condo listed at $700,000 in a prime neighborhood; however, the person may afford a leasehold in the same neighborhood listed at $550,000. Financing is only one factor of many but it may be key in considering leaseholds as an alternate form of owning a home.
TOP 3 reasons people buy leaseholds:
SOLD PRICE (Apr 2019): $725,000
Appreciation: $436,000 in 10 years
SOLD PRICE (Jun 2019): $495,000
Appreciation: $130,500 in 3 years
Source: Craigslist
WHAT TO WATCH OUT FOR IN LEASEHOLDS
There are many different types of leaseholds available and each leasehold is unique from one another in terms of its ownership, management, rules and so forth; as a result, it’s always important to talk with your Realtor about your needs and motivation to see whether a leasehold property is right for you. If you’ve fallen in love with the lifestyle and convenience that a leasehold property offers, or if you like the financial advantages that leaseholds can offer, here is a list of items that you should generally be aware of when buying a leasehold:
1. There is no guarantee that the landlord will renew the lease agreement. As most leasehold contracts last for a period of over 50 years or more (99 being max) and neighborhoods change with the supply and demand of housing over time, most landlords are not willing to guarantee renewal until they’ve analyzed the marketability of the land that the property sits on at the time of the expiry date. For this reason, most leasehold contracts do not have a written clause that guarantee renewal without some conditions. So, if you’re considering to buy a leasehold, it is recommended that you have at least 30 to 50 years remaining in the lease. This allows you the option to sell or hold funds and use the property as a rental investment.
2. The landlord has the right to increase rent on the use of the land at the end of the lease term unless stated otherwise in the lease. When you’re considering a leasehold property, it is important to find out whether the leasehold is a pre-paid leasehold or non-prepaid leasehold as this will tell you when and how rent on land will be paid. A “pre-paid” leasehold means that the rent on the land has already been paid in the beginning of the lease term . A “non-prepaid” leasehold is one where you would be required to pay rent in the form of a monthly fee. As you can see every leasehold is different from another and having a Realtor who has a strong understanding of leasehold contracts is important to have at your side.
3. The landlord has the right to sell the land in which the leasehold property sits on at any point in time unless stated in the lease contract. Depending on the terms of the lease, because you own the property and not the land, it’s important to know, as a leasehold purchaser, that there is a possibility that you could be forced to sell (at fair market value) and move if the landlord decide to sell or re-develop the land. With a freehold property, the only time you would only be forced to sell if your mortgage is in default.
4. There are fewer lenders who are willing to finance leasehold properties especially privately owned properties. Most big banks are not willing to lend money to someone who owns a leasehold property unless the land is owned by large entities like City of Vancouver, UBC or SFU. With large entities as landlords, there may be less risk of the landlord selling or increasing the rent on the land. This becomes more difficult for privately owned leaseholds so if you’re considering one, be prepared for stricter guidelines.
5. The market value of a leasehold does not appreciate significantly compared to a freehold property and may even drop in value as it gets closer toward the expiry date. This is a key consideration for those comparing leasehold vs freehold. Although each property and location’s market varies, as you get close to lease expiry, buyers find this less favorable due to the fact that there is uncertainty with what happens at lease renewal. There are many possible outcomes depending on the market and on whether the owner is private vs. the City of Vancouver for example.
PART 2 – Financing a Leasehold Property
In Part 2 of this series we have a video interview with a mortgage broker on the common questions regarding financing a leasehold property.