 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. 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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