What is a land lease? Understanding how land lease agreements work can be difficult. However, if you are a landowner or a potential lessee interested in leasing land, you must understand how a land lease works. So, to get you started, here’s a great overview of the key things you should know about land lease agreements.
What is a land lease?
When you purchase a home as part of a land lease, there is one major difference from a typical residential real estate transaction. With a land lease, you don’t own the land on which the house is built. As such, you only own the house while you lease the land from an owner, which could be an individual or company.
Land leases are much more common with commercial properties. But there are some situations in which they’re used for residential homes as well. A residential land-lease arrangement might seem more ideal for a mobile home. This is because you can move the home when the lease is up. However, there are also single-family homes, such as vacation getaways in coastal areas, on land that has been leased for many years.
Type of land leases
The two main types of land leases are subordinated and unsubordinated, although unsubordinated leases are much more common because they provide more rights to the owner of the land.
Subordinated land lease
With a subordinated land lease, a landowner agrees that the title of the property will be used for a leasehold mortgage for the tenant’s loan on improvements to the property. That is beneficial to the lessee because it can increase their chances of getting a construction loan. However, a subordinated land lease agreement can be risky for the owner. If the lessee defaults on his or her construction loan, the loan could result in foreclosure. This means the owner could lose his or her title to the real estate property itself. Due to the riskiness for the owner, he or she may demand an increase in rental fees for the land lease and impose stricter control over the lease transactions.
Unsubordinated land lease
With an unsubordinated land lease agreement, the landowner does not permit the property to be used for a leasehold mortgage. That means there is no risk of foreclosure, so it is a safer option for landowners. If the tenant defaults on the construction loan, the ownership of the land improvement can go to the landowner. It could also increase the leasehold’s fair market value, which is beneficial for owners. Also, with an unsubordinated land lease agreement, the landowner may charge a lower rental fee because the agreement carries less risk.
Pros and cons of a land lease
Here is a look at some of the pros and cons of a land lease arrangement.
- Buying a home on a leased property could cost less than buying a single-family home outright because you’re not paying for the land. Also, if you’re going to live in a property that’s on the land and possibly improve it, you could try to get a deal on the cost of the lease.
- It’s also possible you could avoid paying the full property tax bill each year, but it depends on how much the property owner wants to charge you for that expense. You might be asked to pay it as part of your contract.
- If you move into a land-lease community, you could get amenities such as a recreation centre or pool as part of the overall cost of living there.
- There are some cons to land-lease agreements, however. A lender might not want to give you a mortgage on an unsubordinated lease if they are going to have fewer rights to recover their investment than the landowner.
- You also might not know whether there are environmental issues with the land, or where the potential property encroachments are, as an example.
- Another risk is that if your lease expires, the owners may evict you from the property. You can try to plan for what happens next if you know when a lease period ends, whether for your agreement with the landowner or the landowner’s personal lease. However, it takes a significant amount of money and time to plan and execute a move. If you are not prepared for it, this can be a major issue.