When Buying Leasehold Property Is Better Than Freehold

By on June 26, 2015

You can probably tell that this is a loaded topic. Because if given a choice, anyone in a healthy frame of mind would want their properties to be freehold than leasehold. Would you prefer to have a car that you own forever or 1 which you only own for 10 years? The answer is blatantly obvious.

But this is a very sensible question when we put it in the perspective of investing. Because if for example, you have set a target of 20% total profit, whether it’s leasehold or freehold doesn’t make much of a difference.

If you are a flipper, you can flip and flop all day long without considering the lease. If you are a sub-seller, the lease also won’t come into play unless you have a buyer who is obsessed with the number of years remaining. And if you are a cash flow guy, you probably will generate a high cash flow from leaseholds. So what’s the issue here?

Freehold

The most valuable feature of freehold property is obvious. You get to fully own the house without having an expiry date at the back of your mind. Your children will also be able to reap the rewards of your shrewd investment in future. Property value will almost certainly rise over the long term. But remember that even though you own the land, governments can still legitimately takeover it should they see it as necessary.

The pros of leasehold

Yes there are instances where having a lease is advantageous.

Appreciation

As long as you are not talking about a property with 30 years or less remaining on it’s lease, a leasehold property will appreciate and depreciate along with freehold properties in the vicinity. Leasehold properties tend to start depreciating when it gets close to the magical number 30.

The reason being that once you hit that number, a buyer might find it more difficult to get a bank to approve a mortgage. And certainly a bank will have justified reasons determined from their multi-million-dollar research work. Anyway in recent years, the market has observed that leasehold land can be renewed by the authorities. So even though land leases are written in black and white, they can be re-written as well.

If that is the case, then you might have ask yourself the question – Is there a distinction between the 2?

Rental returns

As an investor, you might use it as a bargaining chip to negotiate for a lower price when buying. I know that I’ve just mentioned that there is not much of a difference previously. But that does not mean that a seller will have the same mindset. In fairness, most leasehold sellers would probably agree that their prices should be significantly lower than a house that is freehold. This will play into your hands.

When you purchase at a lower price, your capital is lower. This means that your mortgage would be lower. Which translate to a lower monthly loan repayment. That in turn, means the rental you collect will be more profitable than an expensive freehold acquisition.

Let’s illustrate this with a simplified example.

leasehold vs freehold example

As you can see from the example, leasehold property actually has a higher profit and return.

Tenants won’t care about the remaining lease on your property. They care about the location, amenities, transport, infrastructure, shopping malls, etc. Rental rates are dependent on that. So you can charge a rental as high as a comparable freehold property. This will translate into better earnings for you.

Capital gains

If you have a full intention to sell your property for capital gains, “leasehold versus freehold” will only affect you if your investment horizon is in the decades. You property is not going to see depreciation (unless the economy implodes) at least until the magic number 30.

So if your exit strategy is within 8 years, and the property you are eyeing has 60 years left, the lease is not really a big factor. You can still churn and burn as long as you pass on the house to the next buyer.

What now?

If you are buying real estate for investment, you concern is the returns you will generate. And very often the land lease has nothing to do with it. It’s just the concept of longevity that is playing at the back of your mind. And that could be screwing up your investment decision.

You don’t need to leave a legacy and let your investments generate an income forever. Unless you have a very long and extended investment time frame, it doesn’t matter as much as you think it does. Focus on the price, your capital, expenses, and rental. If you acquire a winner, you are going win even if there is only 10 years left on the lease. And who is to say it will not be renewed?



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