If you’re venturing into the world of real estate, there’s a lot to learn – and the meaning of the term “leasehold” is one of them.
Most first-time buyers assume one thing is certain — when you purchase a house or piece of land, it’s yours from that point forward.
You can live there forever and even pass it on to future generations.
But not all land works this way.
Whether this is a possibility depends on if you have a leasehold or freehold arrangement.
In the United States, leaseholds are available for both commercial and residential properties, and they can have a significant impact on your ownership.
Let’s look at what a leasehold is and how it works.
1. What is a leasehold?
A leasehold, also called a leasehold estate, is a term in real estate that describes ownership.
A lessee (tenant) holds the rights in a leasehold property for a specific period only.
Normally, the lease agreement for a leasehold property will outline the terms of the lease, including the lease’s length, the rent payments, and any other conditions or restrictions.
Leaseholds can last anywhere from a few months to several decades.
When the lease term ends, the property will revert to the landlord who leased it to you unless you extend or renew your agreement.
2. How does leasehold work?
A leasehold is a legal agreement between a landlord (landowner) and tenant (lessee).
During the lease term, the tenant can use the property as outlined in the lease agreement and pays the landlord in exchange for the right to use the property.
Though the landlord remains the owner of the property, the lessee holds the right to use it for the duration of the lease term.
When the lease term ends, the right to use the property will revert to the landlord unless the lease is renewed or extended.
Depending on the terms of the agreement, the lessee may be able to renew the lease or purchase the property outright.
3. What are the different types of leasehold estates?
There are four types of leasehold estates.
An estate for years is the most common, and this is the one that will be primarily covered in this blog.
Estate for years
This type of leasehold allows tenant occupancy between two specified dates.
Upon the expiration date, the property must be vacated.
Estate from period to period
This type of leasehold has no specified end date, and as a result, a party must provide notice when they wish the leasehold agreement to end.
Estate at will
This type of leasehold is when the agreement has no specified dates attached to it.
To get the tenant to leave, the landlord may be required to evict the tenant.
Estate at sufferance
This type of leasehold occurs if a tenant stays beyond the end of a lease (with or without the landlord’s permission).
4. What are important terms to know when discussing leaseholds?
Expiration date: This term refers to the date the lease ends.
Lease rent: This term refers to the amount due in exchange for the use of the land.
Lease term: This term refers to the length of time the lease covers.
Lease fee interest: This term refers to the amount that the owner will accept to transfer fee simple ownership.
Reversion: This term refers to the process of giving the land back to the original owner.
Surrender: This term refers to the terms of the reversion.
5. What is the difference between a leasehold and a freehold property?
Compared to leasehold properties, freehold properties are more common in the United States.
Thus, this may be what you’re expecting when you’re first buying real estate, especially if you’re looking at a single-family home.
Freehold properties are when you own a property in its entirety and perpetuity.
Not only do you own the property, but you also own the land that it’s built on until you sell it.
There is no time associated with your purchase, so you have “full” ownership (even if you’re paying monthly mortgage payments to your lender).
6. How do you know if you’ve bought a leasehold property?
By law, all properties must state if the tenure is freehold or leasehold.
7. How long is a lease?
Although leases on commercial properties can be as short as a few months, residential leases are typically 1 year (although they can vary).
Occasionally, however, you may encounter ground leases, wherein you buy any improvements on the land, but lease the land itself for a long period (ex: 99 years).
Battery Park City in New York City is one key example.
If you’re looking at this kind of property, avoid those that don’t have long left on the lease.
Some lenders won’t even offer you a mortgage if the property has fewer than 80 years left on the lease agreement since the property will return to the freeholder once the lease ends.
8. What happens when a lease ends?
The property will return to the freeholder/landlord of the property when the lease ends.
This occurs even in the case of a ground lease and even if you’ve paid off the mortgage on the improvements in full.
This can be frustrating to many buyers who have been at a property for 80+ years and suddenly have nothing once the lease ends.
A ground lease property can be a dwindling asset if you intend to hold onto a property long-term.
Additionally, extending the lease on a ground lease can be a complex, costly, and time-intensive legal process.
Make sure it’s the right property before you commit!
9. Can you extend a ground lease?
You can, but it isn’t the easiest process.
Here are some tips that can help you be most successful.
Ask the freeholder to extend the lease before you buy and be prepared to pay more.
Extend the lease after you bought it, but don’t wait to start this process because it can take some time for this process to occur.
Understand the cost implications. The shorter the ground lease, the more it’ll cost to extend it.
Talk to the other leaseholders in your area. If you own the ground lease to a condo or coop, then you’ll need to go in as a group.
10. Can you buy the freehold?
Yes, you can buy the freehold if the landlord (freehold owner) is willing to sell.
If they are planning to sell while you have an existing leasehold with them, then they must offer you the right of first refusal to buy it.
11. Can you sell your ground lease property?
Yes, you can.
This is one of the main benefits of having a ground lease property rather than just renting from a landlord traditionally.
Just keep in mind that the length of your leasehold will impact your ability to sell and your property value overall.
For example, if you buy a property with a 90-year leasehold, and you stay there for 20 years, then the next leaseholder will have just a 70-year leasehold.
This may seem like a long time, but lenders can be difficult with leaseholders under 80 years.
12. What are the pros and cons of leaseholds for landowners?
Pros
Steady income
For the landlord (freeholder), leasehold agreements provide steady income.
Tenants will make consistent rent payments for the duration of the lease.
Limited liability
Certain leasehold agreements make the lessee (tenant) responsible for maintaining and using the property during the lease term.
This limits the liability that the landowner could be responsible for in terms of damages.
Flexibility
Not only does a leasehold agreement provide flexibility for the tenant, but it also provides flexibility to the landowner (freeholder).
Cons
Limited control
Landlords (also called landowners or freeholders) are the owners of the property.
During a lease term, they have limited control over how their land is used.
The tenant is able to use the property however the lease agreement outlines.
Likewise, tenants have limited control over the land because their lease agreement will expire at some point.
Uncertain future
Leasehold agreements have a specific duration.
When they end, tenants may be uncertain about what will happen next.
Potential conflicts
Just like renting a property, landlords and tenants can sometimes have contentious relationships regarding rent payments, property maintenance, or use of the property.
Short-term lease
A “short-term” lease is a relative term.
For certain residential or commercial properties, a short lease is less than a year.
This is for seasonal or temporary rental purposes.
However, in the context of a ground lease, “short” leases are anything under 80 years, which can pose an issue for tenants trying to get a loan for a leasehold.
13. What are the different types of leaseholds?
In the U.S., landowners can enter into several different leasehold arrangements.
Here are the most common types.
Ground lease
A ground lease is a long-term lease on the land only.
The tenant usually owns the improvements and buildings on the property.
Net lease
This type of lease requires the tenant to pay rent and other taxes associated with the property, including property taxes, insurance, and maintenance costs.
Gross lease
You may consider a gross lease when a landlord is responsible for paying all costs associated with owning and maintaining a property.
The tenant/lessee will only pay a set amount of rent while they use the property.
Short-term lease
This type of lease normally has a duration of less than one year.
They’re commonly used for seasonal and temporary rental properties.
14. How does a leasehold impact land use planning?
Leasehold arrangements have a defined duration in most cases.
So, landowners must consider the future of their property when the lease term ends (or often before it).
This matters in several scenarios:
It impacts how landowners use their property during their lease term
It dictates how tenants handle improvements or investments in the property, especially commercial properties
15. What are some key considerations for landowners when entering into a leasehold agreement?
Before you enter into a leasehold agreement in the U.S., you should keep the following in mind.
The length of the lease
This is one of the most significant considerations as the length of your lease term will affect your property value as well as future land use.
Depending on what you want to use the land for, you’ll need to consider a long-term or short-term lease.
The rent payments
The lease agreement should outline the rent payment structure, and you should ensure you understand the payments as outlined.
Consider whether these payments are reasonable and fair for the property.
The maintenance and repairs of the property
Depending on the type of leasehold agreement, you may be responsible for the maintenance and repair of the property as well.
Decide whether this is realistic for you and your situation.
The restrictions on land use
Certain lease agreements may restrict how you can use your property.
Review these restrictions throughout and decide whether they will impact your land use plans enough that you should reconsider moving forward.
The renewal and purchase options
Does the leasehold agreement include options for renewal or purchase?
Does this align with your future plans for the property?
Final Thoughts
When it comes to real estate ownership, you can enter into either a leasehold or freehold arrangement.
Freeholds are more common in the United States, but leaseholds still exist, which means it’s important to understand how they work.
This will allow you to make an informed decision if you desire to move forward with a leasehold property.
Additional Resources
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.
Prior to starting Gokce Capital, Erika received a Bachelor of Architecture from the University of Southern California and a graduate degree in Urban Policy from Columbia University. She worked as both an architectural designer and engineer in New York before joining the New York City Department of Housing Preservation and Development.
Erika currently lives in the New York Metropolitan area with her spouse, daughter and cat. She is originally from Chicago and still considers herself a midwesterner at heart.
Erika also loves to read, write and travel (fun fact, she has visited all 50 states and more than 30 countries!). Her new book, Land Investing Mistakes: 11 True Stories You Need To Know Before Buying Land, is now available on Amazon.