Leasehold vs. Fee Simple

The two forms of land ownership that exist in Hawaii also exist everywhere else. It's just that on the mainland mostly only business space is leased. The two forms (collectively called Land Tenure, abbreviated "Tnr" in the listings) are Fee Simple (FS) and Leasehold (LH). "Tnr" is Land Tenure, the way the owner holds title to the property. You either have title to the Fee interest or the Leasehold interest.

This explanation is mainly for leasehold farms. Leasehold condominiums are different in many respects, although they do have monthly lease rent, renegotiation periods and expiration dates.

Fee Simple is the way you normally hold title on the mainland, only you just didn't know the name. When you bought a house, you also bought the land and you owned the house and land until you sold it. With leasehold, you buy the house (or, for condos, the space within the walls) and the right to take over the remaining time on an existing land lease. Hawaii just has more leasehold property than any other state. In fact, 55% of all Hawaiian land is owned by something like 17 major land owners, the largest of which is Bishop Estate. On the Big Island, Bishop Estate owns thousands of acres. This land is broken up into various sized farm lots averaging 5 or 6 acres each. All the leases were leased out in the 50's and 60's for farm purposes at an annual cost of around $300 to $400. There was no up front cash. Over the years the lessees built structures and planted crops (mostly coffee and macadamia nuts) which added value to the land that did not belong to the lessor. Hence, a trade in leases began in the 70's. By the 80's you could sell your lease with 30 to 35 years left on it for around $100,000. The leases have regular renegotiation periods where the lease rent goes up using the Honolulu Price Index as a bench mark. Right now the average lease rent is about $800 to $1500 per year. A typical leasehold property of 6 acres with a three bedroom house and 28 years left on the lease might sell for $250K to $600K. A similar fee simple piece would be around $800K to over a million. When the lease expires you can get a new thirty five year lease at a renegotiated rate.

The biggest drawback to a (farm) lease is the lease transfer fee (condos, Gentleman Farm leases, and residential leases do not have the transfer fee). If you have all the productive land specified in your lease planted in a crop then the transfer fee is %10 of the gross sales price. If you have neglected your crops severely (let them become overgrown with weeds and vines, etc) or failed to plant a crop in the productive area, then the transfer fee is %20. Therefore, it is important that you farm your land wisely and save a portion of your profit every year to offset the transfer fee when you sell. Leasehold is still a good deal, because if you were going to farm for a living, paying the debt service (interest) on a million dollar loan for fee simple property would eat up all your profits. Similar leasehold property would typically be under $500,000. Leasehold is the only way to go for professional farmers or those who want to own a hobby farm, want acreage, and can only afford the leasehold prices. And lease rent is a deductible business expense!

If a person did not want to farm at all, but could only afford leasehold, there are professional farmers who will enter into a contract to farm your land, keep it in compliance with the Lessors requirements, in exchange for the crops. Terms are negotiable. I have heard of people who just wanted to wash their hand of the whole farming experience who got nothing in exchange for the crops but a totally buffed out piece of land. Others receive as much as 10% of the gross sales and their lease rent paid. Basically, what ever you can work out with the farmer.

Leasehold condominiums are another story. There are a number of different private and corporate entities that own condominium projects and lease the condos. So you don't actually buy the condo, you buy the lease to the condo from the present lessee. There is no lease transfer fee. On the UPdate, the amount of the monthly lease rent and the date the lease expires appears in the bottom line of the listing under the "remarks" box. You can also tell if a listing is Leasehold or Fee Simple by looking under the heading titled "Tnr" with is the abbreviation for Land Tenure. FS will be for Fee Simple and LH will be for Leasehold. The fee interest in some residential (not agricultural) and condominium leases can be purchased.

If you have any further questions please don't hesitate to ask. Also, When you arrive in Kona I can explain this situation further. The best thing to do is to consider the merits of each property on a case by case basis. In some cases, leasehold will be the best option.
Mahalo, Harry

COMMONLY ASKED QUESTIONS ABOUT LEASEHOLD:

(Q) What is the additional monthly payment I make in addition to my mortgage payment?
(A) The additional monthly (or yearly) payment you make to the Lessor is the lease rent. Only condominiums have monthly lease rent. Lease rent on leasehold farms is paid annually. Your mortgage payment is totally separate and is between you and your lender. It has nothing to do with the Lessor. If you pay cash you will not have a mortgage payment, but you will still have to pay lease rent. When you purchase leasehold property from the person living on it (the lessee) you buy the improvements (for a farm, the contents for a condominium) and the right to have the lease transferred into your name. The lease is with the Lessor (land owner), not the person you bought the lease from (former lessee). At the time you take possession of the property (called "at closing"), the Lessor transfers the lease to you, and all it's terms then become binding on you for the rest of the lease term or until you sell it to someone else. Every lease has lease rent renegotiation periods and an expiration date, among other stipulations and requirements. When you make an offer on leasehold, but before you are required to go through with the purchase, you are given a copy of the lease and a leasehold disclosure to study. You have time to show it to a lawyer if you desire. If there are terms or conditions in the lease that you don't like, you can cancel escrow and get your deposit back.

(Q) What happens if you purchase a lease that is about to expire?
(A) It depends on the Lessor. For condos and residential leases, it depends on what is stipulated in the individual lease. For Bishop Estate leasehold farms, you can wait for the lease to expire and renegotiate a new 35 year lease, or you can renegotiate the a new 35 year lease while in escrow.

(Q) What happens at the end of the lease hold time? Say it expires in 2035, does it go back to the state?
(A) There are very few leases available from the State of Hawaii. The agricultural properties you see on the other side of the highway when you leave the airport heading toward Kailua are State owned ag leases. But the Bulk of the leases available on the Big Island are owned by Bishop Estate. The Greenwells own some ag leases up behind the Kealakekua Ranch Center in Captain Cook. A few other families have some ag leases and several own condominium projects. Bishop and/or it's for profit arm, Kamehameha Investment Corp, also own the land under several condo projects in Kona.
Most leases specify the method of renegotiating a new lease when the present one expires. The present lessee almost always has "first right of refusal". If you can't arrive at terms you can live with you don't have to renew, but you usually have first choice. Remember, when you make an offer on a leasehold property, you will be provided with a copy of the present lease to review before you make your final decision to buy or not. At that time you should see what the renewal terms are as well as lease rent renegotiation terms.

(Q) can the monthly payment go up?
(A) Rent renegotiation periods usually come every ten years after the first 15 years of the lease. Right now Bishop Estate is offering very favorable lease rent at renegotiation time for full time farmers of leasehold farms, $165 per acre. For some, this is even less than they have been paying. If you added up all the lease rent you pay over the life of the lease it's still way less than the extra interest you would have to pay on the additional money you would have to borrow to buy a similar piece of land in fee simple. Leasehold condos are more uncertain. There are many different individual Lessors and each lease stipulates a different method of renegotiation. If you fall in love with a leasehold condo you must study the lease carefully before you buy it.

(Q) What happens when the lease expires?
(A) Most Bishop Estate leases have a surrender clause. But in practice Bishop usually gives the lessee the option to negotiate terms on a new 35 year lease. To date, no one has ever been asked to vacate the premises when their lease expired.

The person who asked this next question had read all of the above, so I am including it here to hopefully clarify this situation:
(Q) At the end of the lease, what happens if they ask for, say, another $50,000 to get a new lease? Do we have any recourse?
(A) When the lease expires, and you want to renegotiate a new lease so you can continue to live on the property, only the lease rent amount will change. They will not exact a fee, like the $50,000 you mentioned. The lessor will not be "selling" you a new lease. They may charge a higher lease rent for the new lease because of inflation. The amount is usually determined as a percentage of the appraised value of the underlying Fee Interest. It's a complicated form of appraisal, and can only be done by a professional. If you disagree with the lessor's appraisal, you can hire your own appraiser. Sometimes the two appraisers appoint a third, and they average all three. If you still disagree, and you want to leave, you can take the house with you.

When you buy leasehold property you are buying the improvements and the right to take over the lease from the present lessee (the person who is presently leasing the property). You are not buying anything from the lessor (the entity that owns the underlying Fee Interest in the property). The lessor does not get any of the money the Buyer pays to the Seller. The lessor may exact a transfer fee from the Seller however, usually 10%. But on residential leases, it is usually only the administrative costs that are charged to the Seller. At closing, the lease is transferred into your name from the Seller's and you begin making the lease payments to the lessor where the Seller left off. The lessor does not partake in the sale except to agree to transfer the lease from one person to another.

(Q) ABOUT LEASEHOLD CONDOS: Harry, what is the advantage to the seller to do a lease hold? Is it tax advantage reason?
(A) I believe the "Seller" you are referring to in your letter is the person who listed the unit for sale, the current lessee. When you purchase a leasehold condo your are purchasing the right to take over the existing lease from the current lessee. They have a lease and have no choice but to sell their leasehold interest. The lessOR must agree to the transfer, but they are not the ones selling the lease. You are buying the right to take over the lease from the current lessEE, you are not buying anything from the lessOR. You pay cash (or your mortgage company pays the cash) to the lessEE for his interest in the lease, then you become responsible for the monthly lease rent to the lessOR. The lessOR does not get any of the cash.

The lessOR only gets cash if the lessEE buys the fee interest. Once the lessEE buys the fee, there is no longer a lease, so they stop paying lease rent. When these condo projects started out, the developer leased them instead of sold them out right; he became the lessOR. Now there are many lessees, but still only one owner (the lessor) of the underlying fee (Fee Simple) interest in the property. Occasionally some fee owners (lessors) decide to sell the fee interest to the lessees. Some may take them up on the offer and some may not. That is how some complexes end up with some fee simple and some leasehold units. The fee owner may offer the fee or retract the offer on a whim. If the lessees disagree with the price they have to go to court. Right now, several of the projects in town have the fee offered, and the lessees are happy with the prices. Some projects never offer the fee.

Does this make any sense?? If not, call me, it would be easier to explain over the phone. As you have noticed, many condos in Kona are leasehold projects. Many people mistakenly treat leasehold and fee simple the same. But leasehold should be cheaper than fee simple. But because people don't know the difference, they pay the same for a leasehold condo as a fee simple one. Then they find out that they have to pay 30 to 60 thousand dollars more if they want to buy the fee interest. If the leasehold unit is priced correctly, when you add the cost of the fee buy out, the unit should be priced like a similar, already fee simple, unit. When you get to Kona, I can help you determine if a leasehold unit is worth buying along with the fee interest. I am doing a Kona Alii unit now. Cost of the lease is $78,000. The fee buy out is $38,300. Similar fee simple units in the same complex sell for about $120,000. Also, similar fee simple units in other projects sell for around $120,000. So the price is right. Why buy the fee?? Periodically the lease rent renegotiates as stipulated in the lease terms. If the periods are 10 or 15 years, the rent can go up ten times or more. At the Keauhou resort the lease rent jumped from $54/mo to $306/mo. So you have to take each project on an individual basis, compare the prices, see if the fee is available, read the lease, make a decision. I would always recommend buying the fee at the same time. If it's not available, I'd pass.

This information is only meant as an overview of leasehold and cannot possibly cover the entire subject or account for the differences in all the various leases available. For the latest information you are advised to call Bishop Estate or other lessor directly. For interpretations of different leases you are advised to seek the counsel of an attorney.

Koa Realty Inc.
Kailua-Kona HI
96740

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808-989-3491