Land Lease
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In a typical home purchase, the buyer of the home purchases a house as well as the land that it sits on. However, there is another more affordable option for people who are looking to limit their spending as much as possible: a land lease. A land lease involves purchasing a house and renting the land underneath.
What You Should Know
- A land lease, or a ground lease, is an arrangement where the buyer purchases the house but rents the land that the house sits on from a third party
- Land-leased properties tend to be significantly cheaper to purchase than similar traditional homes
- In a subordinated land lease, the owner of the land puts the title of the land as collateral for the mortgage of the buyer
- You may not be able to obtain financing if your lease term on the land expires before the term of your mortgage ends
What is a Land Lease?
With a land lease, also known as a ground lease, the buyer buys the home from the seller and they rent the land from a third party. This situation involves paying a fee to the land lessor for the benefit of using his or her land. The primary reason why people may be interested in a land lease is so that they can afford to become homeowners. There are some key differences between traditional homes sold together with the land and homes sold on leased land.
Price: The price of a home sold on leased land is typically significantly lower than the market price of a similar property where you purchase the home and the land together. For example, if a traditional 2000-square feet home costs $400,000, the same home on leased land would cost about $130,000. This difference is a huge motivator for people to go through with a land lease.
Amenities: Homes built on land that is leased typically do not have any private amenities. However, there may be community-shared amenities such as swimming pools, tennis courts, etc.
HOA Fees: HOA fees for properties on leased land tend to be quite higher than the regular fees on a traditional home. This may also serve as an indicator when searching home listings. If the HOA fees are unreasonably high, then there is a chance that the property may sit on leased land.
Type of Land Leases
Homes purchased or built on leased land are typically financed through mortgages. Therefore, if you do purchase this type of home, you will be making a mortgage payment and a rent payment every month. There are two main types of land leases that relate to the risks the owner of the land faces if the homeowner defaults on their loan:
Subordinated land lease - On a subordinated land lease, the owner of the land offers the title of the land as collateral to the lender that the buyer is working with. This puts the landowner under a lot of risk as they may lose ownership of their land in the case that the homeowner defaults on their mortgage. To make up for this risk, subordinated land leases typically come at a higher rental price. Moreover, the fact that now the owner of the land has an interest in your success in paying off the mortgage can give you the upper hand later on if you find yourself in a situation where money is tight.
Unsubordinated land lease - The opposite is true in an unsubordinated land lease. Here, the land and the property are kept separate. Therefore, if the homeowner defaults on their loan, then the lender only has a claim on the house and not the land under it. This is a safer alternative for the owner of the land.
Where to find a Land Lease?
The availability of properties on leased land varies by state and the type of properties found can vary as well. One of the most common forms of leased-land communities are trailer parks. Trailer parks can generally be found anywhere in the US. In some states, such as California, land leases are mainly found in suburban communities.
Some types of leased-land properties include retirement communities, properties on leased reservation land, and leasehold condos. Leased-land retirement communities are most common in states such as Florida and Arizona, while leasehold condos can be found in Hawaii.
Pros & Cons of Land Leases
Before you purchase a property on leased land, make sure that you fully understand the benefits and drawbacks this option presents.
- Lower Price - As mentioned previously, the price of homes on leased land is distinctively lower than the price of a similar traditional home. For people who cannot afford to purchase a home that costs hundreds of thousands of dollars, land-leased properties give them the opportunity to become homeowners without saving considerable amounts of money for a good portion of their lives.
- Amenities - Since you only own the house and not the land, you will probably have to pay very little or no property taxes at all. Moreover, as far as taxes go, you can also deduct the rent you pay on the land when filing your income taxes.
- Lower Property Taxes - Leased-land communities sometimes offer all types of amenities like clubhouses, tennis courts, or swimming pools, that the homeowners on the leased land can access.
- Lost Equity - The greatest asset of owning a home is building equity on it and accumulating wealth. With a property on leased land, however, you risk losing this equity when the lease contract expires.
- Increases in Rent - A disadvantage of leased-land properties is the possibility that the owner of the land can increase rent in the future, especially when ownership of the land changes hands. This can make the lower price you paid on the home not worth it if rent payments are taking a significant amount out of your budget. Moreover, with traditional homes, your fixed-rate mortgage payment stays the same throughout the life of the loan, and no adjustments for inflation are made. If you have a leased-land property, however, your rental price and HOA fees will most likely go up at the rate of inflation.
- Harder to Sell - Although more expensive, most people still prefer to purchase traditional properties where they can own the home and the land. This puts you at a disadvantage if you, later on, want to sell the home on leased land.
- Less Flexibility - If you are renting a place and you are unsatisfied with the way the landlord runs the property, you can simply wait for the lease to expire and not renew it in the future. However, this is more difficult and more costly to do when you own the home but not the land.
- Harder to get a Mortgage - You may need to prove to the lender that you will be able to stay in the home throughout the life of the loan.
Should you buy a property on Leased Land?
In order to answer this question, you may need to consider a few things that will help you determine if a property on leased land is the right option for you.
Remaining time on the lease
The time that is remaining on the lease is important in more than one aspect. First, if the length of the lease is shorter than the time you plan to stay in the home for, then you need to know what happens next. What happens to your interest in the property after the lease expires? Secondly, the time remaining on the lease can impact your chances of getting financing to purchase the home. Lenders typically want the lease term to be longer than the mortgage term. For example, if you have a 30-year mortgage, the time remaining on your lease must be at least 30 years. Lastly, it would be easier for you to sell the home in the future if your lease term is long enough to provide the future buyer with the conveniences mentioned earlier. Therefore, you would want your lease term to be as long as possible.
Terms of surrender clause
Make sure you are aware of the terms of your contract with the owner of the land. If the lease expires while you are still using the property, is there a possibility to renew the lease? Will you also have to give up the improvements that you have made to the land and property? To save time, money and effort make sure to get these questions answered prior to getting into such an arrangement.
Adjustments to rent and HOA fees
Increasing costs can make living in a leased-land property not worth it in the long run. If the rental price is to be adjusted during the term of the lease, make sure to ask how often and by how much it will be adjusted. The same goes for HOA fees. This will allow you to make a more realistic forecast of your monthly expenses and budget in the future.
