Financing a Leasehold Estate
Are you looking at a property where the seller is open to a leasehold option? Perhaps someone has mentioned this type of ownership to you in the past but you’re not quite clear on the concept? If so, you’re not alone. Buying and financing a leasehold estate property does take a bit of explanation but in reality it’s simply a difference in who owns what in the transaction and for how long.
Leasehold estates tend to be more in clusters in a neighborhood or in a condominium project but in general they’re much less common than a traditional purchase. When someone buys a property and finances it with a conventional mortgage that person owns the property outright, both the land and the structure and continues to own it throughout the life of the loan. Such a purchase is referred to as “fee simple.”
What is a Leasehold Estate
Leasehold ownership means the buyers have exclusive rights to occupy the property and have title to it but the sellers continue to own the land. How does financing a leasehold work differently compared to a fee simple purchase? With a leasehold, it’s essentially a long term rental agreement. If you finance a leasehold property and the leasehold term has been completed your ownership interest is over. Why even bother with a leasehold? Because you can purchase a property at a lower price if you only own the structure and the improvements. And you’re also responsible for paying all property taxes, homeowner association dues and insurance.
How it Works
Financing a leasehold estate can be a bit tricky at first but both Fannie Mae and Freddie Mac allow for leasehold financing and have laid out their guidelines for them. Note that there are several guidelines to follow but we’ll point out some of the more important ones. First and foremost, the term of the leasehold estate must continue for at least five years past the maturity date of the loan. For a 30 year loan, that would mean the leasehold must be written for at least 35 years but can be for as long as the buyer and seller agree. A 50-year term is not uncommon.
At the end of the lease term, full ownership is transferred back to the seller. This is referred to as a “reversion.” Leasehold transactions can also include an option to purchase the property at a future date during the term of the leasehold or at reversion.
Appraising a Leasehold Estate
The appraiser must be experienced in appraising a property in such a transaction and the most important information that must be included in the report regards comparable sales in the area or project showing that leasehold agreements are common for the area showing a “market acceptance” of leasehold purchases. This is why condominium projects can have a number of such comparable sales or even financed 100 percent with leasehold financing. Single-family residences are much less likely to show a number of leasehold purchases as traditional fee simple are much more common.
As always, reach out to me if you (or anyone you know) have any questions on this. I can help.