Leasehold Estates – Ultimate Guide + FinancingOctober 6, 2019
You don’t have to purchase property to occupy it! Instead, you can enter into a leasehold estate (LE), of which there are several types. In this article, we’ll answer the question of “What is a leasehold estate?”, starting with a leasehold estate definition. Then, we’ll compare freehold estates vs leasehold estates and discuss the distinguishing features of leasehold estates. Next, we’ll lay out the different leasehold estate types, including pros and cons as well as leasehold financing. Finally, we’ll explain how Assets America® can help finance an LE and answer a few leasehold estate FAQs.
What is a Leasehold Estate?
In this section, we’ll answer the question: What is a leasehold estate? At its simplest, the leasehold estate definition is an arrangement between a landlord and tenant. Specifically, it gives a lessee the right to occupy/use a landlord’s land or buildings for a specified period. Accordingly, the landlord maintains legal title to the property while the tenant exercises temporary ownership. Importantly, the tenant does not have the right to sell, pledge, or assign the property. Typically, an LE lasts more than one year and requires a written lease. Naturally, the lessee loses the right to occupy the landlord’s property after the leasehold agreement expires.
Freehold Estates vs Leasehold Estates
Typically, a freehold estate arises out of a property purchase. The buyer has a freehold estate, meaning the buyer is free to use the property in any legal manner. In contrast, a leasehold estate gives the lessee only the right to possess the property for the term of lease. The freehold estate property owner has a fee-simple interest, meaning the owner has free reign over the property. Accordingly, the owner can sell, give away, pledge, bequeath, improve, develop, raze, or otherwise manage the property.
When more than one party shares a freehold estate, they own the property concurrently. Paradoxically, the law refers to them as joint tenants, even though they are owners. Each joint tenant has equal rights, including the right of survivorship. Another freehold estate arrangement is tenants in common, in which there is no right of survivorship. Usually, married couples are tenants by entirety and constitute a single entity. In California and several other states, married couples share community property, which doesn’t provide a right of survivorship. Explicitly, under community property law, spouses can name anyone they please as beneficiary to the property.
Video: Leasehold Estate vs Freehold Estate
Other Leasehold Estates
There are several specialized types of LEs. Two important ones are:
- Ground Leases: In a ground lease, the lessee has ownership interest in land improvements but only possessory interest in the land. Explicitly, in a ground lease, the lessee leases the land from the owner. Land improvements include buildings and other structures, as well as infrastructure preparation and land subdivision.
- Co-ops: In a cooperative LE, tenants own shares of a corporation that owns the property. Typically, the property is an apartment building. The shareholders lease their apartments from the corporation, giving the shareholders possessory rights.
Distinguishing Features of Leasehold Estates
Although there are different types of LEs, all share certain distinguishing characteristics:
- Location: An LE has a specified address.
- Property: The LE applies to physical land and the buildings and natural resources on the land. Moreover, an LE can include fixtures or machinery permanently affixed to the land. For example, these can include windmills, fencing, moats, lighting, wells, mines, and other features.
- Personal: Although an LE applies to real estate, state laws consider an LE to be personal property. Some states place restrictions on LEs. For example, the maximum term for an agricultural LE in California is 51 years.
- Expiration: Most LEs specify an expiration date and parties refer to them as a tenancy of years. Naturally, the owner and lessee negotiate the term, subject to state laws. Interestingly, the lease may permit the lessee to surrender the property back to the landlord before expiration. However, the lease usually requires the landlord’s acceptance of the surrender.
Types of Leasehold Estates
We next discuss the four leasehold estate types.
In fixed-term tenancies (or term of years tenancies), lessees take temporary possession of the landlord’s property until lease expiration. Invariably, the LE agreement specifies the lease term or expiration date. Alternatively, the lease may end upon a specified event occurrence, such as the following year’s harvest. Despite its name, a term of years tenancy can expire sooner than a year. Upon reaching the end date, the lease automatically expires without notice. However, the lease may give the lessee certain options, such as option to renew the lease. Additionally, the landlord can, at any time, offer to buy back the lease from the lessee. Sometimes, the lessee may offer to buy the property from the landlord.
The lease can run for a stated time period, such as week-to-week, month-to-month, or year-to-year. Normally in a periodic tenancy, the lease periods match the rent payments. Either party can issue a notice to vacate that will end the leasehold when the current period expires. Normally, a party must deliver a notice to vacate with sufficient notice, as required in the lease. For example, a month-to-month tenant may require 30 days’ notice before vacating the property. Typically, a periodic lease is a written document, although it’s possible to have an oral lease agreement. However, states may limit the term of an oral lease. In some states, a periodic lease without a stated period defaults to a month-to-month tenancy.
Tenancy at Will
This tenancy, which we also call an estate at will, doesn’t have a specified termination date. Rather, either party can end the tenancy with reasonable notice, such as 30 days. Typically, this arrangement doesn’t involve a formal lease and/or rent. For example, parents may allow a grown child to live in their basement for free. Sometimes, a tenant will have tight time requirements to take occupancy before signing a lease. Therefore, the tenant enters into a temporary tenancy at will until the parties sign a lease.
Tenancy at Will Termination
Sometimes, a tenancy at will involves residential rental property. Importantly, in some states the landlord must show cause in order to evict the resident. Here’s a helpful resource showing the eviction process for each state. Note that this may be true even when the parties haven’t signed a lease. On the other hand, in some states the landlord can terminate a tenancy at will without cause. But the flip side is that the tenant can terminate at will as well. Sometimes, the lease language allows the tenant to stay for as long as desired. In this case, the landlord doesn’t necessarily have the reciprocal right to evict at will.
State laws can specify conditions under which a tenancy at will terminates, including:
- A tenant’s attempt to sublease the property
- A tenant causes damage or otherwise reduces the property’s value
- The landlord sells the property or otherwise transfers its interest in the property
- The landlord signs a lease with another tenant
- The death of the landlord or tenant
Tenancy at Sufferance
A tenancy at sufferance (or holdover tenancy) occurs when a tenant illegally remains on the property after lease expiration. Of course, landlords can evict the tenant at will, but can also extend the lease and continue collecting rent. Legally, the squatter may be a trespasser that the landlord can evict at any time. In some states, a landlord can meet resistance to eviction with force, even deadly force. Whereas a trespasser has no right to possession, a tenant at sufferance has this right until eviction commences.
Typically, should the landlord impose a new lease on a residential tenant at sufferance, that tenancy will be month-to-month. For commercial tenants of over a year’s tenancy, the new tenancy will be year-to-year. For short commercial tenancies, the new tenancy matches the term of the expired one. Indeed, with proper notice, the landlord can charge a higher rent on a commercial tenancy at sufferance. A tenant cannot establish a tenancy at sufferance simply by leaving behind property on the premises.
Pros and Cons
The pros of leasehold estates from the landlord’s viewpoint include:
- Monetizing property by leasing it out and collecting rent.
- Reclaiming property after a lease expires.
- Structuring a lease to leave maintenance tasks and utility costs to the lessee.
- Inheriting leasehold improvements when the lease expires.
The cons of an LE from the landlord’s viewpoint include:
- The landlord cannot evict the tenant without cause before the lease terminates.
- Unless the lease contains a rent escalation clause, the landlord can’t raise the rent until the lease expires.
- Under certain net-lease arrangements, the landlord must pay for maintenance, insurance, and/or utilities, even if tenants balk at reimbursements.
- Lessees might secretly modify or damage the premises.
- The landlord might not be able to fully rent out the premises.
- Landlords must deal with delinquent rents and other tenant issues.
In conclusion, you may find this article on the dangers of buying leasehold property helpful.
Video: Leasehold Property Advice
Leasehold Mortgages & Financing
The holder of a long-term ground lease can arrange a leasehold mortgage. In this arrangement, the lessee gives a lien to the lender in return for financing to improve the property. The lessee uses the mortgage proceeds to pay for construction or renovation of buildings on the leased land. Once developed and rented out, the property can pay for the ground lease and debt service on the mortgage. Normally, the landlord places an SNDA and other protections in the ground lease to guard against lessee default. The lease must explicitly permit the lessee to encumber its leasehold interests in order to get a leasehold mortgage. Many types of lease agreements other than ground leases prohibit leasehold mortgages.
How Assets America® Can Help
We at Assets America® can help finance a leasehold estate through our extensive network of private lenders and banks. If your lease permits a leasehold mortgage, we can arrange ones starting at $5 million, with no upper limit. We can arrange construction loans or bridge loans to holders of ground leases that want to develop the leased land. We can also arrange mini-perm and take-out loans once construction is complete.
Also, we can arrange financing for cooperative LEs. In addition, you might be a developer or investor looking to build/renovate and lease out properties. If so, we are happy to evaluate arranging financing starting at $5 million. Of course, we offer a wide range of financing options that you can use to achieve your goals. Contact us today for a confidential, no-obligation consultation at 206-622-3000.
Leasehold Estates FAQs
Which type of leasehold estate has a definite beginning and ending date?
A fixed-term LE has a definite beginning and end date. If no end date is present, then the lease becomes a periodic LE or perhaps another form. If a lessee fails to depart after the end date, it becomes a tenancy at sufferance. Under those circumstances, the landlord can evict without notice.
To terminate an estate for years leasehold estate, how much notice is necessary?
None. The lease terminates automatically, without notice, on the end date. If either party wants an early termination, the party must give notice sufficiently in advance for negotiations. Periodic tenancies may require notice of termination at least 30 days in advance.
Can a leasehold estate act as collateral for a mortgage loan?
Yes, if permitted in the lease. This is a common arrangement for ground leases. The lessee and its lender can do nothing to reduce the landlord’s rights under a mortgage loan. Routinely, Co-op Leasehold Estates receive mortgage financing collateralized by shares in the co-op corporation.
What leasehold estate ends at the death of either the lessor or the lessee?
Any leasehold estate can end when either party dies, but this isn’t always necessary. For commercial property involving partnerships, multi-party LLCs, or corporations, the death of a principal is immaterial. Even if the lease agreement is between individuals, it can specify procedures other than termination when a party passes.