 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 landowners. 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.
For additional information, contact us toll free at 1-800-922-6811
or locally at 808-254-1515 or via e-mail at TheStottTeam@Stott.com
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