Consider Both Sides In Land-Lease Deals

May 12, 2014

Question: I'm currently in the process of buying an apartment in a co-op building that has what's known as a land lease. The lease won't expire until 2058, but I know that my mortgage company needed to know when it expired because they would not give me a loan unless there were at least 10 years left on the lease. What exactly is a land lease, how common is it, and what are the possible detriments to buying an apartment in a building that has a land lease?

Emily, New York, N.Y.

Emily: A land-lease property is one in which the land beneath the building is owned by someone else. While such an arrangement can make buying a property a little more complicated and can in some cases reduce the unit's resale value, it's usually not a big problem, and it certainly isn't a reason to dismiss the transaction out of hand.

Although land-lease properties are relatively uncommon, they do pop up in some big cities, especially New York. Typically, they occur when a real-estate investor refuses to sell the land that a developer covets for a residential building. If the developer really likes the location, and can't find a good plot of land somewhere else, sometimes he or she will agree to a land-lease arrangement, paying to lease the land for a specified period -- like 50 or 99 years -- and then erecting the building. Land-lease arrangements are also known to occur when developers convert a rental property to an owner-occupied cooperative building, but the original owners refuse to sell the land.

There are downsides for people who want to buy units in these buildings. The properties are sometimes harder to finance and consequently harder to sell, possibly reducing their resale value. There also could be some extra costs involved in owning the units, as well as some negative tax implications.

But land-lease properties also have an upside: They're often discounted relative to other nearby properties, offsetting some or all of the risk and hassle involved in owning them. In some cases, that discount is tiny, but in other cases, it can be as high as 25%, real-estate agents say.

One reason for all the hassle is that someone has to pay for the lease on the land, and often, that cost is split up among the owners of all the units. In many cases, that monthly lease expense is tacked on to the maintenance fees that are being charged to individual unit owners.

Another weak point is that some lenders are afraid to extend credit for a land-lease property if the lease is likely to expire within a few years. Although it's extremely unlikely the landowner would refuse to renew the lease or decide to build something new on the site -- indeed, most leases are renegotiated in advance of the expiration -- lenders still worry about their collateral, and the owner could jack up the lease fee. That, in turn, would raise the unit owners' costs and possibly reduce the market value of the units.

Despite all that, if the land-lease arrangement has plenty of time before it expires -- say more than 20 years -- there's little reason not to dive in. Once some of the terms are worked out, "it's like any other purchase, and as long as you go into it with your eyes open," you should be fine. At the very least, you could be getting a bigger, nicer unit than you would have been able to afford otherwise.

By Patrick Barta, WSJ

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