What is a leasehold property? Pros and cons

Leasehold properties are a misunderstood form of property ownership.

Yes, they are (oh so) cheap, but does a small price tag make them a good investment?

In this article, you’ll learn what a leasehold property is. You’ll also get an unbiased view of the pros and cons of owning a leasehold property in NZ.

What is a leasehold property?

Leasehold is a type of property ownership in New Zealand.

It's where you own the building on top of the land, but you don’t own the land beneath it.

When you buy a leasehold property, you buy the building and a right to lease the land for a set period (e.g. 30 years).

Because you rent the land, you pay rent to the land owner. This is called ground rent.

You also don’t get to rent (lease) the land forever. When you buy a leasehold property, you buy the right to use the land for a set amount of time.

This is all written in the contract with the landowner.

Any leasehold property you buy has a “lease” attached. This will set out things like:

• The amount of ground rent you have to pay
• How often the owner reviews the ground rent (e.g. every 7 years). This is where the owner can increase the rent you pay
• How long the lease is, and what happens at the end (e.g. can you renew, or does the owner get the land back?)

What types of properties are leasehold?

Not all leasehold properties are the same, and you won’t find them everywhere.

There are approximately 17,000 leasehold properties in New Zealand. Around a third of them are located in Auckland.

Among these properties, approximately:

- 69% are apartments

- 18.5% are flats or townhouses

- 10% are houses

What are the pros and cons of a leasehold property?

As with all properties, leasehold properties come with pros and cons.

Pro #1 – Lower cost

Leasehold properties are often cheap. That’s because you don’t own the land. This can make them an affordable option for some people.

Pro #2 – Smaller mortgage

Since you don’t have to buy the land for a leasehold property, you'll pay less, and your mortgage will be smaller. There are extra costs, like ground rent, but we’ll cover that in a moment.

Pro #3 – Changes in land value don’t impact you

Leasehold properties offer a level of protection against fluctuations in land value. Since you don’t own the land, you don’t care as much about what happens to the price of the land.

Because of this, some people will see leasehold properties as lower hassle.

Now let’s talk about the cons.

Con #1 – Increasing ground leases

The biggest issue with leasehold properties is that the ground rent goes up.

Sometimes a person will look at buying a leasehold property, and the ground rent looks cheap. But then the ground rent goes up and becomes expensive.

Usually, the ground rent gets reviewed every 7-21 years.

And the kicker is that the ground rent is usually tied to the value of the land. That means if the property market goes crazy and the land doubles in value, so does your rent.

Many investors have to pay way more than they thought they would at the start.

For instance, there was recently a case in Auckland where the ground rent on a leasehold property started at $4.5k a year.

After the landlord reviewed the ground rent, it shot up to $16.6k. That’s an enormous $12,000 increase!

Put in a weekly amount; that's an increase from $86.50 to $320 per week. Oof!

Con #2 – Hard to sell and no capital growth

Selling leasehold properties can be challenging.

Since the ground rent can go up (and you don’t own the land), few people want them.

That means leasehold properties often take a long time to sell. And in the meantime, you still need to pay the ground rent.

Leasehold properties are also less likely to go up in value. That’s because they have a finite shelf life. With a freehold property, you own the land forever. But, with a leasehold, you have to give the land back at some point.

So leasehold properties get less desirable over time as the time left on the lease dwindles.

Con #3 – Limited control

If you buy a leasehold property, you will often have limited control over the land.

You might be unable to make changes or add extra dwellings to the land, although this depends on the terms and conditions of your contract.

Con #4 – Need a larger deposit to get a mortgage from the bank

Banks need you to have a larger deposit before they lend you money for a leasehold property.

This is often 50%.

So while the property might look cheap, you still need a sizeable deposit to buy one.

Do the pros outweigh the cons

Some property buyers will decide that leasehold is the right fit for them.

But most property buyers should stay away from leasehold properties. They are cheap for a reason and are generally not a good long-term investment.

Case Study: Leasehold property in Auckland

Let's go through an example of a leasehold property.

At the time of writing, there is a 2 bed, 1 bath apartment overlooking the harbour in Auckland CBD. It’s got 2 secure car parks, which is essential given the price of parking in the city, and it rents at $650 per week.

The asking price is – wait for it – $199,000 (yes, that’s right).

The current rent for the apartment is $650 per week ($580 for the apartment and $70 for one of the car parks).

This gives the apartment an annual income of $33,800.

At first glance, the gross yield stands at an impressive 17%.

But, it’s essential to take a close look at the net yield.

Assuming a 100% mortgage at an interest rate of 6%, the monthly interest amounts to $995.

Operating expenses, including rates and insurance, would likely cost $10,000.

If you have 2 weeks a year without a tenant (vacancy), the cashflow is positive $10,560 per year.

That's equal to $203 per week.

Sounds promising, but that’s before the ground rent.

The owner has to pay almost $11,000 per year (or $208 per week) in ground rent.

That means that if you buy this property you will lose $5 a week as an investor. On top of that, you could still have to pay taxes because of the interest deductibility rules.

That wouldn't be so bad if your property was going up in value, but that’s unlikely to happen for a leasehold property.

But there’s even more to consider.

When the lease renews, the ground rent could go up by another $10,000. That would mean you're losing $200+ a week ... and your property isn’t going up in value to compensate.

This is why, when considering a leasehold property, investors must assess:

- The cashflow and yield after all expenses (net yield)

- Whether the property will go up in value

- Whether the bank is willing to lend you the money for the property

Often the numbers on a leasehold property look good at the start, but once you dig in and factor in all the costs, they look less attractive.

What are the other types of ownership in New Zealand?

What other property types can you consider if a leasehold property isn’t right for you? Let’s go through the three main ones.

Freehold

Freehold property is the most common ownership type of property in NZ.

In a nutshell, it means you own the property and the land it’s built on forever. It’s yours.

The word “freehold” comes from the fact that it is “free from the hold” of any person or entity other than the owner.

This means, unlike other types of ownership, the owner of freehold land owns it outright.

There are no ground rents like you have with leasehold property, and there’s no body corporate to worry about.

Also, because you own the land, you can do whatever you want with it, although, of course, there are some exceptions. You still have to follow all the laws, e.g. the Resource Management Act.

Compare this to a cross-lease. You may need to consult your neighbours even if you want to build a carport on your side of the fence.

The sale of a freehold property requires less paperwork. But buying a freehold house is also more expensive. That’s because you have more freedom, and it’s the most desirable way to own land.

Cross-lease

A cross-lease is another structure of land ownership in NZ.

This is where you and your neighbour own the land underneath your two houses together. You then lease the ground from each other. That’s why it’s called a cross-lease.

This arrangement (usually) lasts for 999 years.

For example, two flats are next to each other, and they are on a cross-lease. You decide to buy one of the flats. If you do that, you will:

- Own all the land with the other owner

- Own all the buildings on your exclusive part of the land (i.e. your house)

- Have a long-term lease for the part of the land you have exclusive use of.

Cross-leases are the most like a freehold property, but you have to consult your neighbour about changes you want to make to your part of the property.

Unit title

A unit title is where you own land along with a whole load of people.

This is common when you buy an apartment. You own the interior of your apartment. Then you own the exterior of the building and all the land with the other owners.

The moment you sign up to own a unit title property, you become a member of that building’s body corporate.

This is an organisation that manages the building and land.

So, if you buy an apartment in a block of 10, you co-own all the land beneath the apartments with the 9 other owners.

You’ll also then pay money to the body corporate each year. This covers the insurance for the building and any repairs.

The amount you pay depends on:

- the size of the apartment

- the number of car parks you have, and

- what’s in the building (e.g. pools and elevators)

So ­– should I buy a leasehold property?

Leasehold properties offer a low-cost alternative option for property purchases in NZ.

But, there are often not good buys because of the hidden and increasing costs.

Usually, property investors buy a rental property because they want it to go up in value. That likely won't happen with a leasehold property.

That’s why we often recommend property investors do not buy leasehold properties.