Risks of buying a leasehold property

February 2020

The low entry price of leasehold properties often attracts foreign and first home buyers. Leasehold is not well understood, and can be full of pitfalls. This post highlights what you need to know and the risks to look out for.

Warning: Buyers keen to purchase leasehold property must surround themselves with property and legal experts to ensure that costly pitfalls are avoided.

Contact me for a free due diligence checklist for buying a leasehold property.

What is a leasehold property

Leasehold homes are scattered across New Zealand and are often owned by church groups, developers or councils. In central Auckland about 15% of apartments are on leasehold land.

With a leasehold property you buy an exclusive right to possession of the land and the buildings for a specific period of time according to the terms of the lease.

The buyer of a leasehold property becomes known as the lessee and the land owner the lessor. In a unit title development, all apartment owners in a building become members of the body corporate. The body corporate effectively becomes the lessee.

You don’t own the land

With leasehold, it is the owner of the land that benefits from the increase in the value of the land over time. You only have the right to live there and may own an ageing house or apartment in need of repairs, that could be decreasing in value.

You could lose money

It is not uncommon for leasehold properties to lose value. Most of the capital gain on a freehold property is achieved from the land. According to QV.co.nz a two-bedroom apartment, in the Scene 3 building in central Auckland that sold for $65,500 was originally purchased in 2006 for $490,000 and then resold for $280,000 in 2014. That means the original buyer lost $210,000 on the unit and the second buyer lost $214,500, before allowing for selling costs such as agent's fees and legal expenses.

Uncertainty over the amount of the ground rent increase, was one of the reasons for the property's slide in value. The prices these properties sell for, set a benchmark for the value of the others in the complex.

The length of the lease determines the value of a leasehold property

Most leases are in perpetuity – they keep renewing. But some leasehold properties in central Auckland are limited to 70 or 90 years. At the end of the term of the lease the property goes back to the owner of the land and the person who bought the leasehold property has nothing.

When you try to sell a leasehold property, the value of the property will depend on the number of years that remain on the lease. There is a huge difference between the value of a property that has 50 years left to run and one that has only 5 years.

Lease reviews can make ground rents unaffordable

All leasehold property leases have review dates where the ground rent that is paid is recalculated. With some leases, the review may occur every 21 years and with others it may be every 7 years.

Rent reviews are usually based on a fixed percentage of the land value. With Auckland's soaring land prices, the increase after 21 years can be significant. Even if you can afford the new rent, the property may lose value because of the higher ground rent, making it difficult for you to move from there. Consider the effect of your annual ground rent increasing from $8,300 to more than $70,000 a year?

The owners of 110 leasehold houses on the edge of Auckland’s Cornwall Park are now paying up to $90,000 per property per year according to a NZ Herald story. 15 homeowners have been forced to walk away from their properties because the ground rents have crippled them and the remaining homeowners say they’ll likely do the same.

You pay for all the outgoings

With a leasehold property all outgoings are the responsibility of the lessee and not the land owner. These include city and regional council rates, body corporate fees (if it is a stratum title), insurance and maintenance.

Weather tightness issues

Beware of buying an apartment that requires remediation work. It is not uncommon for the prices estimated for repairs to treble or quadruple and the time line for completion to extend. You have no control over the work undertaken in a project like this. It is a big risk.

In 2019 an Auckland waterfront apartment in need of remediation sold for $20,000. The one-bedroom-plus-study unit in the Scene One complex had a large deck, was tastefully decorated and had uninterrupted views across the harbour. Records show the owner had bought it in December 2002 for $311,200.

Banks insist on a bigger deposit for leasehold properties

Banks require a bigger deposit for the purchase of a leasehold property. The banks are less willing to lend against leasehold property because they can only use the building for security.

It can be hard to exit a lease

Your only exit options are to sell or illegally walk away. You can't physically move the house or apartment. The length of time remaining prior to the rent review is a crucial factor in the value and the sale-ability of the property.

Leasehold property is hard to sell

It can be more difficult to sell a leasehold property, particularly if you are nearing the end of the lease or approaching a review period.

Some real estate agents charge a commission for selling a freehold property that is equivalent to what would be charged if the home were freehold. This is because it takes longer to sell and there is more work involved in selling a leasehold property.

Beware of rent-free offers

Beware of inducements to buy leasehold properties. Buyers should ensure the purchase price paid, reflects the fact they are buying leasehold and not be swayed by rent free offers.

At the end of the rent-free term, the ground rent will rise to market rates. Buyers of leasehold apartments in Parnell came with 11 years free rent. One leasehold townhouse in Parnell that was sold in 2006 for $265,000 was again sold in 2012 for $75,000.

Understand what you are getting into

Read the lease, also known as the deed or memorandum of lease document. It sets out the rights and obligations of the parties. The terms in the lease will set out:

· How many years the lease is for, and any rights of renewal

· the amount of rent you have to pay to the owner (the ground rent)

· how often the ground rent is reviewed by the owner

· costs for maintenance, rates, insurance and other items associated with the property

· Any restrictions as to the land use. i.e. no pets or no commercial use

Making alterations to Leasehold properties

When the lessee wants to make any additions to their home they need to check the lease to see if it contains any clauses relating to alterations and obtaining the lessors’ consent in writing.

The landlord can charge a reasonable amount for legal or other expenses incurred in giving consent. These could include surveyors and solicitor`s costs.

Disputes

Disputes can arise about rent reviews, renewals of the lease term, assignment of the lease, or maintenance and repair obligations and who bears the cost of these.

The first step when there is a dispute or problem is to look at the lease agreement and

what you have agreed to.

Can you buy the land?

Some leases give the lessee the option to purchase the land freehold on expiry of the lease with a formula included to calculate the sale price of the land at that time. Dilworth Trust lessee's are offered a 20% discount if they want to freehold the property half way through the term.

Buyers need support

Unless buying leasehold property is something you do every day, you need experts who are 100% on your side and committed to helping you get what you want. Exclusive Buyers Agency does just that. We work exclusively for the buyer.

Lorraine Burns

Buyers Agent - Licensed (REAA 2008)