When you buy a house, you typically purchase the property and have full, comprehensive ownership over the home and the land it sits on. While this isn’t the most common type of homeownership in the US, some metro real estate markets include houses for leasehold purchase.
Today, let’s explore what a leasehold is, how leasehold ownership compares to freehold ownership, and the benefits and downsides of a leasehold property in detail.
What Is a Leasehold Property?
Put simply, a leasehold property is a personal property that you own for a certain amount of time without owning the land that it is built on. It's contrasted with freehold or fee simple ownership, which is much more common in America; leasehold property arrangements are more common throughout Europe in countries like the UK.
What Does Leasehold Mean?
In a nutshell, a leasehold means that you "lease" to own a particular leased property from its true or long-term lender. With a leasehold agreement, the property owner or lessor gives the leaseholder the right to live on the property (and for all intents and purposes act as though they own the property) for a specific timeframe. This fixed period of time can be short-term (month-to-month) or a longer period such as a year or two years.
In exchange, the lessee or homeowner makes a down payment and pays rent (sometimes called ground rent) every month like a traditional rental tenant. You pay leasehold interest on your purchased leasehold estate, but the interest depends on things like whether the property is a new build and other factors of the lease agreement.
A leasehold property arrangement is different from a rental arrangement in a few key ways:
Leasehold property arrangements are longer than rental leases in most cases. For instance, you might rent a property for a year before having to renew your lease. If you purchase a leasehold property, you’ll own the property for five to 10 years at minimum, then have the option to renew your lease later
You have the freedom and flexibility to make leasehold improvements to the property or to otherwise modify the property so it better suits your needs until the end of the lease.
The different types of leasehold properties include single-family homes, but they are much more common for commercial property lots, such as malls, business structures, and so on. In these circumstances, business owners borrow for leasehold properties so they don’t have to take full ownership of the land and decide what to do with the land if they ever need to move or switch up their business premises.
Simply put, freehold ownership is "full" ownership. While you still might make mortgage payments every month during the term of the lease to your mortgage lender, you own the property plain and simple, and when your mortgage payments are done, you don't have to make any more payments toward the property or the land it sits on.
Freehold properties make up the vast majority of purchasable properties in the US. However, properties with leaseholds are more common in certain cities such as Miami and in states like New York and Hawaii (the latter of which places a premium on land ownership since there is a very limited amount of it).
Generally, leasehold properties are available in places with less open land for new development. You can find leasehold homes and buildings in developed metro areas rather than rural areas with plenty of available space.
For starters, you can sell a leasehold property, even though you don’t technically own the property outright. What you actually sell is the lease to the leasehold property, at which point the new owner continues making payments to the “true” or freehold property owner in your stead.
In this way, buying a leasehold property offers greater flexibility compared to renting a property — in the latter case, you can’t simply give your rental to someone else in exchange for money. The new renter has to form a separate agreement with the property owner.
Even better, you can sell your leasehold without notifying the original property owner. The more time left on your leasehold lease, the more valuable your property may be. This extra versatility means that you are never truly locked into a leasehold lease if you can find another willing buyer. That helps to negate one of the downsides mentioned below, namely that leasehold loans usually have fairly long terms.
Leasehold Properties Can Be a Bargain
Because leasehold properties aren't sold out right, they are oftentimes sold at a discount compared to freehold properties. If you are looking to buy a home for the first time or otherwise don't have a lot of cash saved up, you may still be able to purchase a house if you look for leasehold properties specifically. These are sometimes available at a significant discount.
Leaseholds Make Ideal Rental Properties
It's possible for a leaseholder to rent your property to someone else. You still make payments to the freehold owner for the property, but you can rent your leasehold home to someone else and pocket the difference (depending on market conditions).
Leasehold properties oftentimes make ideal rental properties for investors. You don’t have to worry about paying for the land or owning the property overall, which can result in some administrative and managerial headaches.
Even if you don’t plan to rent your leasehold home, taking out a leasehold loan means you get many of the benefits of renting your property without being as limited to traditional rental real estate, like apartments, smaller houses, etc.
Leaseholds Have Lower Down Payments
Because leasehold properties are sometimes cheaper than freehold properties, they also often have lower down payments. Again, this makes leasehold real estate more accessible for first-time investors or homebuyers.
You Can Renovate as Much as You Want
Since you “own” a leasehold property you purchase, you can renovate it as much as you want, with the exception of any terms and conditions that may be stated in your leasehold lease. This is contrasted with traditional rental agreements. When you rent a property, you usually aren’t allowed to renovate or make changes to the property beyond adding some basic decorations.
Interest Rates Are Remarkably Consistent
Leasehold properties have one final benefit: consistent interest rates. In times of market volatility or fluctuation, this can be a major advantage in that you'll be able to predict how much you'll pay for your leasehold property for years or possibly decades to come.
Are There Downsides To a Leasehold?
However, there are downsides to owning a leasehold property as opposed to purchasing a freehold property to keep in mind.
You Don’t Own the Land
You never own the land on which a leasehold property sits. This inherently diminishes the value of purchasing a leasehold property compared to purchasing a freehold property.
You Still Pay Rent
Furthermore, purchasing a leasehold property means you still pay rent to be a true, freehold owner. Rather than putting money toward your mortgage and building equity in your home, you pay rent and don't build up anything. If you have a long-term goal of homeownership and never have to pay for your house again, leasehold ownership is not the best choice.
You’re Committed for a Long Time
Many leasehold loans are offered for time frames ranging from five years to 10 years or even longer. When you sign a leasehold loan, you are oftentimes locked into that financial arrangement for a very long time, especially compared to rental leases (which are for months or up to a year, generally).
Due to this limitation, you should be sure that you want to purchase a leasehold property before signing on the dotted line.
Leaseholds Are Rare Outside of Certain States
Outside of states like Florida, New York, and Hawaii, it can be difficult to find leasehold properties available for purchase. Due to a combination of factors ranging from culture to plentiful real estate opportunities and more, leaseholds are simply rare in the United States.
These types of properties are much more common in Europe, and especially the UK. If you’re looking to take advantage of the above benefits, you may have to hunt for the perfect property for much longer than if you were to look for a freehold property for the mortgage.
The Bottom Line on Leaseholds
As you can see, leasehold ownership can be advantageous in some circumstances. However, it can be tough to know whether purchasing a leasehold property is better than purchasing a freehold property. In these cases and more, you need to know you have the right financing ready to go to finalize your purchase ASAP.
That’s how Vaster can help. Not only can our knowledgeable loan officers help you find the perfect loan for your needs, but they can also help you understand whether one home purchase or another is ideal for your goals. Contact us today to learn more.