The Pros and Cons of Leasehold Properties
A look at what leasehold properties are, how they work, and how they compare to freehold properties.
By Emily Southey | 7 minute read
A leasehold property is a type of real estate ownership that gives someone a temporary right to hold property. In the case of a leaseholder agreement, the lessee essentially becomes a tenant. They own the property for a predetermined period of time but they never own the land it is built on. Instead, this remains under the ownership of the lessor or landlord. That said, although the lessee in a leasehold agreement does not have the right to the land, a leasehold estate is still often considered personal property.
How Does a Leasehold Property Work??
Knowing how leasehold properties work is crucial if you want to buy one. First, in a leasehold agreement, the property owner (that is, the landlord or lessor) grants the leaseholder or lessee permission to live in the property for a specific period of time. In exchange, the leaseholder must provide a down payment. That said, the down payments required for leasehold properties are often less than that required for traditional homes. Once the down payment has been made, the leaseholder pays rent, typically on a monthly basis, much like a tenant renting a property. However, there are a few advantages that leaseholders have over the average tenant. Namely, since they are living in the property for a longer period of time, they can make home improvements as they see fit. For example, a leaseholder can renovate the property, build an addition, or even construct an entirely new structure (and even rent out an addition or new structure to a tenant of their choosing). Further, a lessee also has the right to sell the leasehold to someone new without the property owner’s permission. The catch with leasehold agreements is that at the end of the lease, the property reverts back to the original owner, along with any improvements or additions that have been made. In some circumstances, if the leaseholder wishes to stay longer, a new lease or a lease extension can be negotiated, but the owner is under no obligation to agree to such an offer. Please note that leaseholds exist for both commercial properties, such as malls or office spaces, as well as residential properties, like single-family homes and condominiums. .
Should You Buy a Leasehold Property: The Pros and Cons
To help you determine if buying a leasehold property is right for you, the experts at Wahi outline the pros and cons of leaseholds below.
The Pros of a Leasehold Property
The main pro of buying a leasehold property is that they tend to be far less expensive than traditional properties. This is because, especially in major cities, developers will pay far less to lease a plot of land and build on it than they will to buy land from another owner. In turn, these financial savings trickle down to the leaseholder. So if you are on a tight budget, a leasehold property might be a great option.
Second, although there is less freedom and flexibility than in a freehold agreement, leaseholders have far more power than a typical tenant. For example, they can make renovations to the house if they wish, rent it out (or part of it out) to a tenant of their choosing, and even sell the leasehold to another party without the owner’s permission (note that the more time is left on the lease, the more valuable the leasehold property is).
Beyond the low cost of leasehold properties compared to typical properties, leaseholds also make for great rental properties. Since the cost of owning the property is low, renting it out can be very lucrative, resulting in a steady stream of income.
Another advantage of leasehold properties is that rates are more likely to remain the same over the course of the agreement. This stands in direct contrast to short-term leases where rents can be raised each year. Whether you simply cannot afford to have your rent raised each year or are a retiree living on a fixed income, leaseholds might be a worthwhile option.
“Leasehold properties are typically far cheaper than traditional homes or freehold properties. Plus, the down payments are often less and monthly lease payments are less likely to increase compared to leases for short-term rentals.”
The Cons of a Leasehold Property
One of the primary disadvantages of a leasehold property is that it doesn’t allow the homebuyer to build equity, since the property simply reverts back to the original owner upon expiry. As a lessee doesn’t technically own the land, they will not benefit from its appreciation (this is the reason that leasehold properties are typically less expensive).
Second, there is always a chance that your lease payments may go up. While some are prepaid, others are not. And sometimes leasehold agreements even stipulate that annual lease payments can be increased by the owner (and this is in addition to taxes, mortgage payments, and more). Therefore, leaseholders must factor in these potential increases in cost.
Further, leaseholders may have less freedom than traditional property owners and may be subject to certain rules. For example, leaseholders may not be allowed to keep pets on the property or sublet it to another tenant.
Another con of owning a leasehold property is that the ownership is temporary, and even if you decide you want to stay in the home longer, there may not be much you can do. Although you can request an extension or renewal of the lease agreement, it is ultimately up to the property owner. Plus, in the event the property owner agrees to a renewal of the lease, they could significantly raise the price to reflect the home’s current value. For this reason, real estate experts recommend opting for a leasehold property with a longer lease.
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Tips for Buying a Leasehold Property
If you are ready to move forward with purchasing a leasehold property, follow the tips below:
- Find a leasehold property with as few restrictions as possible (for example, one that allows you to sell the property before the expiry of the lease if you wish or rent it out to a tenant of your choosing).
- Work with a realtor who has experience with leasehold properties and can provide you with expert advice throughout the homebuying journey.
- Prioritize finding a leasehold property with a long lease agreement (ideally 25 years or longer). The goal is to find a lease that spans a length of time exceeding the amount of time you actually want to live there.
- Don’t forget to budget for additional charges, such as service fees, and other potential costs, like lease payment increases.
- Look for a lease that is prepaid, as this reduces the chances that your lease payments will change over the years.
Frequently Asked Questions
Why would anyone buy a leasehold property?
There are plenty of reasons why someone would buy a leasehold property. Namely, leasehold properties are typically far cheaper than traditional homes or freehold properties. Plus, the down payments are often less and monthly lease payments are less likely to increase compared to leases for short-term rentals. This makes leaseholds an attractive option for anyone on a tight budget or who does not yet have enough money to purchase a home of their own. They can also allow a homebuyer to live in a neighbourhood they love but would otherwise have been unable to afford if the only option was a freehold home. Leasehold properties may also be popular among seniors looking to downsize and retirees living on fixed incomes. Ultimately, leaseholds represent a housing alternative that is less expensive than freehold properties and even short-term rentals.
Can you rent out a leasehold property?
This depends on the terms and conditions of the leasehold agreement you signed. In some cases, leaseholders are free to sublet or rent out their properties to whomever they wish (without the permission or involvement of the owner). However, in others, the owner may stipulate in the lease agreement that the leaseholder is prohibited from subletting the home or must receive permission to do so. Be sure to review the terms of your contract carefully before signing it. We also recommend consulting with a realtor or real estate attorney to ensure you understand the terms of the agreement cover-to-cover.
How do you convert a leasehold property to freehold?
Leaseholders who own a leasehold property may be able to purchase the freehold of the home, either through the law if they meet certain criteria, or by simply asking the owner if they are willing to sell the freehold to them. If you prefer to go the formal route of converting a leasehold property to a freehold one, make sure you have gathered the necessary documents, including the search report, sale agreement, conveyance deed, and mutation. Ultimately, once the ownership title of the property is successfully converted from a leasehold to a freehold and your name is on it, the home will be yours.
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