|
Land or ground
leases exist in several states and state laws vary. On Oahu, most leases
have any improvements reverting to the landowner at the end of the lease.
Already, this has occurred with a single-family house. However, a lease
has yet to expire on a large, multi-family property. Eventually, the
City/State will need to address what should happen to high-rises or hotels
when their leases expire. In all likelihood, there will be a forced lease
extension or possibly a non-voluntary sale (see subsequent paragraphs).
The leases on the first two Oahu multi-family complexes expire in 2007;
three years later, in 2010, the leases expire on 20 other complexes.
Very few people understood leasehold ownership 30 years ago. After I
retired from the Navy in 1975, I attended UH where I obtained an MBA
degree with a major in Real Estate. None of my instructors discussed the
pros & cons of leasehold ownership and what might occur if land values
appreciated. At the time, I owned a home in leasehold, as did many of my
friends and acquaintances. None of us were concerned about reversionary
clauses, as our leases didn't expire any time in the near future. After I
graduated and became actively involved in real estate, the same lack of
concern existed. Contributing was the fact that the larger landlords were
very cooperative in providing homebuyers lease extensions/renewals (at
higher but still reasonable lease rents) in order to enable homebuyers to
be able to obtain better long-term financing.
However, when housing prices soared on Oahu, the large landowners started
taking an entirely different view of their leasehold investments. The
spiraling land values made long-term land leases a poor investment; e.g.,
in 1967, we paid about $35,000 for a leasehold house with a 40-year lease
(until 2007) at a fixed rent of $17/mo. When we sold the home, the
leasehold value was about $100,000, however, the lease rent was still only
$17/mo. Several years ago, the home sold in fee simple for $420,000 and
it's worth about $700,000 in fee today. Yet, if we had continued to own
the home in leasehold today, we still would be paying a lease rent of only
$17/mo.
What the large landowners did was to begin making the fee available for
houses at very high prices and initiate huge increases in lease rents
whenever leases renegotiated. Early on, there were no provisions for
mandatory conversions from leasehold to fee. Therefore, the fee prices
(when offered) were usually done on a take it or leave it basis without
any negotiations between the lessees and the land-owners. Buyers suddenly
started paying far more attention to the terms of land leases. To assist
buyers in understanding all the ramifications of leasehold, the state
passed a leasehold disclosure law making it mandatory for sellers to
provide full disclosure on any leases.
Hawaii had passed a law (Hawaii Land Reform Act) in 1967 that enabled
mandatory conversions of houses from leasehold to fee simple via eminent
domain. However, the law wasn't tested for a number of years, as it wasn't
really necessary until housing prices began rising. In 1984, the law
obtained judicial approval from the U.S. Supreme Court in a unanimous
decision overturning a prior ruling by the Ninth Circuit Court of Appeals.
Following the Supreme Count decision, most leasehold houses on Oahu were
converted to fee, usually via negotiations between landowners and lessees
vice going to court and experiencing the cost and unknown outcome of
having a jury establish the fee prices. Today, there are very few
leasehold houses remaining on Oahu.
The Hawaii Land Reform Act deliberately did not include condos (townhouses
& high-rises) in view of concern that the different form of ownership of
condos would create problems in the judicial review process. In 1991,
Honolulu passed City Ordinance 91-95 with applicability to condos that
basically mirrored the Hawaii Land Reform Act for houses. The law worked
its way through the judicial process to the U.S. Supreme Court that in
1998 provided judicial approval by refusing to hear an appeal in view of
the law's similarity to the Hawaii Land Reform Act.
There are several requirements for a condo to become eligible for
mandatory conversion, one being that 50% of the owner-occupants need to
apply. In May 2002, the Hawaii Supreme Court ruled (Coon decision) that
the 50% requirement as worded in the law should be based on all the
owners, not merely owner-occupants. The impact of this decision is
illustrated by Foster Tower. There are 100 units in Foster Tower. Prior to
the Coon decision, there were only 12 owner-occupants in the building.
Eight owner-occupants filed, easily meeting the 50% criteria (8 of 12).
Today, there would need to be 51 owner-occupants with all of them filing
to make Foster Tower eligible once again (51 of 100), impractical to
achieve. It is estimated that there are only about 40 leasehold condos on
Oahu that could qualify for mandatory conversion following the Coon
decision.
So, why not fix the flawed wording in the law? Mandatory conversion of
condos poses a different situation than mandatory conversion of houses.
With houses, large landowners owned most of the underlying land. With
condos, families own the land under many of the smaller condos with a
large number of the families being Hawaiian. The land often has been in
the family for years, and its loss would be a huge emotional issue. The
landowner families turn out in large numbers whenever there's a public
hearing. Also contributing is the fact that most of the larger condo
landowners have made a voluntary fee offer since the city ordinance was
passed in 1991.
Bill 53 was designed to fix the flawed wording, however, the City Council
will likely defer action on this bill for several years, thereby avoid the
wrath of the Hawaiian community as well as avoiding the possibility of
opening Pandora's box to a whole new set of appeals. Driving the issue
will likely be either the two complexes where the leases end in 2007 or
the twenty complexes that end in 2010. Kahala Beach Apartments still
qualifies following the Coon decision and has become the lead case in
testing the mandatory process. Kam Schools (Bishop Estate) will not offer
the fee on the very valuable land voluntarily, so this one will eventually
go to trial.
Except as noted below, ownership of leasehold has become increasingly
unpopular. If the fee is available, many buyers will purchase it
simultaneously with purchasing a unit in leasehold. Therefore, the
leasehold value for a unit is usually the fee value for a comparable unit
less the cost of the fee and fee closing costs. The cost to buy the fee is
a combination of the unencumbered value of the land offset by the
remaining years on the lease. As the lease gets progressively shorter, the
fee price usually gets progressively higher, particularly near the end of
the lease. If you own in leasehold and intend to hold the property, we
recommend you purchase the fee as soon as practical unless your complex is
one that still qualifies for mandatory conversion.
Also a consideration is the 30-year requirement on the land lease for a
leasehold property to qualify for a 1031 exchange; i.e., there must be at
least 30 years remaining until the expiration of the lease (not
renegotiation). This has already impacted on some of our clients who
wanted to conduct 1031 exchanges. If you own a leasehold property where
the fee is not available, it may be advantageous for you to sell while
there is still at least 30 year remaining on the lease.
So who buys in leasehold (excluding very long leases)? Leasehold is
considerably less expensive than fee. Granted, the value of leasehold will
decline near the end of the lease. But, some buyers are more concerned
about what they're able to do today than what may happen tomorrow. The
fact that a home is leasehold has no impact on the rent that it produces.
So, some investors opt to buy in leasehold. The mortgage payment for some
leasehold homeowners (offset by tax deductions) is less than the cost to
rent a comparable home. So, some homeowners also opt to buy in leasehold.
It may enable them to own in a complex that otherwise would be too
expensive. The important thing about either owning or buying in leasehold
is to understand what you're doing and the limitations of leasehold
ownership. |
