Fee Simple vs. Leasehold |What is Fee Simple in Real Estate?

Introduction

Real estate ownership appears to be quite simple. However, depending on where the property is located, ownership may signify a variety of things.

While it is not universal, certain jurisdictions are known to have two forms of ownership: fee simple and leasehold.

Because land is too large to physically transfer, when a person transfers it, the land does not truly change hands.

To assist overcome this barrier, the United States (and many other nations) have constructed a legal system in which when a person sells land, the interest in the land, or the estate, is really transmitted.

In property law, there are several forms of estates recognized, including freehold estates, which include:

• The fee simple absolute estate, the fee simple determinable estate, the fee simple subject to a condition subsequent estate, the fee tail estate, and the life estate.
• Nonfreehold estates include the leasehold estate for months, the leasehold estate for years, the leasehold estate at will, and the leasehold estate at sufferance, among others.

Identifying the sort of estate interest held by a person entail examining the nature and extent of the individual’s ownership in the land. In this section, we will look at the fee simple absolute estate and the leasehold estate, as well as the differences between the two estate interests.

What is Fee Simple?

A fee simple estate is the most common type of ownership in real property. It is ownership in which the owner has an absolute and unlimited estate in the property. The owner can sell, lease, or mortgage the property. The owner also can pass the property to heirs.

Fee simple ownership is the most frequent kind of ownership for residential real estate owners. In a nutshell, fee simple ownership implies that the buyer receives the title or ownership of the property, including the land and any additions to the land, in perpetuity and with no restrictions on its usage.

As a result, no one may lawfully seize the real estate from the owner as long as they have the fee simple title. Fee simple absolute ownership is another name for fee simple ownership.

Fee simple ownership is absolute ownership of real property in which the owner has unrestricted authority over the land as well as any improvements including buildings that sit on it.

You may have to pay a mortgage and property taxes, but with fee simple ownership, you may sell the entire property or sections of it whenever you choose.

Fee Simple Defeasible vs. Fee Simple Absolute

Fee simple defeasible and fee simple absolute are two variations of fee simple estates. The difference is important, however, as the former may be terminated upon the occurrence of a particular event (such as a breach of a condition), while the latter is permanent.

In other words, with the latter and defeasible estate, the property owner can only be divested of the interest in the property by termination. The condition that renders a less than absolute estate defeasible is known as a “termination event.”

Please remember that fees simple are not defeasible in all jurisdictions.

While many Fee simple estates include an interest in improvements to real property, others do not.

Example: John owns a house in which he lives. If the house is destroyed by fire, the fee simple estate ends, and the title reverts to the landowner.

However, if all of the lands is destroyed by fire, the fee simple estate continues to exist.

The distinction between a fee simple absolute and a fee simple defeasible estate is important because it determines the time period in which you must seek legal counsel on whether or not the property might be subject to foreclosure.

In many states, when you purchase a piece of real property, you are given a deed that establishes your interest in that property.

The deed informs you of your estate, or right, in that property and is also used to establish a chain of title for the property.

Example: When you purchase a home in fee simple absolute, you are given a deed that states that you own the land outright and forever.

Example: When the house burns down from an accident or fire, your title is terminated.

In this case, the lost value of the home must be paid by your homeowner’s insurance provider.

Fee Simple Rights

Fee simple ownership comprises a slew of rights that provide owners a lot of leeways when it comes to changing or developing their property and land, including:

• The right to fly
• Rights of heirs
• Rights to minerals
• The right to alter existing constructions on the property
• Unrestricted rights to rent (within local or state rules) or sell the property at any price they feel fair.

Remember that fee simple property owners must still follow local or state government rules and regulations.

Furthermore, regardless of whether the owner agrees to the sale, the government can always use the right of eminent domain and seize possession of a piece or all of private property in exchange for “fair compensation.”

Advantages of Fee Simple Ownership

The main advantages are:

1. Those who hold fee simple absolute are normally entitled to better property values, as they may use their land as they see fit and do not pay any rent.
2. Those who own fee simple absolute do not usually have to worry about paying taxes.
3. Many feel that the best aspect of being an absolute owner is peace of mind knowing that there is no mortgage for them to worry about.

Disadvantages of Fee Simple Ownership

They include:

1. When understanding the disadvantages of fee simple ownership, it is important to take into consideration that the owner has unrestricted authority over the property.
2. Those who purchase fee simple absolute estates should be ready to maintain the property themselves.
3. Some feel that when you buy in fee simple absolute, you are basically purchasing a “pig in a poke.” What this means is that you do not know what problems or surprises may arise with your land and its value.
4. Because fee simple estates are by nature absolute and do not include an interest in improvements, the property will not be subject to a mortgage, which may enhance its value.
5. Fee simple ownership may prevent you from receiving the money to repair damages to your property as well as provide revenue in the future, something that leasehold ownership can help you with.
6. Example: If you owned your home in fee simple absolute, you could live there or sell it without getting permission from anyone else because it would be yours unless you were sued and lost the lawsuit.

What is a Leasehold?

A leasehold estate is an estate in land where the owner of the estate holds it for a certain period of time. After that period of time elapses, the ownership of the estate reverts back to the person who granted the lease in the first place.

This is in contrast to a freehold estate, where the owner of the estate holds it indefinitely.

The leasehold estate interest is a transitory estate interest in property in which the fee owner allows another person the right to possess the land for a set amount of time.

When a landlord leases property to a tenant in exchange for rental payments, this estate interest is often evident. When someone owns a leasehold estate interest in property, that person cannot normally convey, encumber, or destroy the property.

The leasehold estate interest party never owns the property being leased; instead, he or she just has possession of it for a limited period.

The leasehold estate for months, the leasehold estate for years, the leasehold estate at will, and the leasehold estate at sufferance are the most prevalent forms of leasehold estate interests.

Pros and cons of leasehold ownership

There are several advantages and disadvantages to investing in leasehold real estate:

Pros

1. A lessee often pays significantly less than the traditional 20% down payment required for fee simple ownership to secure a leased property.
2. The lessee may sell the lease to another party without the authorization of the lessor. This is a popular commercial real estate activity.
3. Landlords pay a fraction of what it would ordinarily cost to enter the real estate market, but they still receive the same revenue flow month after month.
4. There is a chance that the lessor will sell their remaining part in the land. The price would be determined by the value of the land and the length of the remaining lease term. Depending on how long into the lease this occurs, it may provide a fantastic chance for the lessee.
5. Long-term leases, unlike other instances where lease rent increases over time, can lock in consistent rental rates that can be renewed for years, if not decades. This is a fantastic alternative for a fixed-income tenant.

Cons

1. HOA fees are levied in addition to the lease payment.
2. A 1031 exchange is only possible if the lease term is more than 30 years.
3. If the lease has less than 10 years left, the lessee must locate a cash purchase because financing is not accessible.
4. Every year of the lease, the value of the land depreciates.
5. A leasehold estate cannot be used to develop equity. While rental property investors may be tempted to the strong monthly income flow for a minimal initial investment, this all ends when the lease period expires, leaving them with no property ownership in the end.

Fee Simple vs. Leasehold

Fee simple is the most common type of ownership, and it gives the owner full control over the property. They can sell, lease, or mortgage it as they please, and they will also receive all profits generated by the property.

When you buy a property, you may become the owner of the building and the land on which it sits. But in some cases, you may only own the building and not the land. This is called a leasehold.

In a leasehold, the owner of the property (the leaseholder) rents the land from a third party, usually a company or the government.

Leaseholders are usually charged rent, and they may also have to pay service charges for things like repairs and maintenance. Leaseholds can be for a set period of time, or they can be inheritable.

There are a lot of differences between fee simple and leasehold ownership.

1. With fee simple ownership, the property is yours to do with as you please. The only requirement is that you pay rent, while with leasehold land, the property is leased by another party in exchange for cash flow and sometimes a minimal down payment from the lessee.
2. When you purchase in fee simple, you have an interest in the property itself, while with leasehold properties, you do not.
3. The lessee is a tenant. The fee simple owner controls all aspects of the property and any development can be done without the agreement of the landlord.
4. One of the biggest benefits to owning property in fee simple is that you can build equity in the property. With leasehold land, there is no way to build equity because a portion of each payment goes to pay off whatever debt was consumed by previous lessees and rent bumps occur every few years.
5. With fee simple ownership, you are able to sell the land. With leasehold land, you are the owner for only a specific period of time.

Example: If your house were on leased land, it would be the responsibility of the landlord to insulate and restore the property when needed. However, if your home is in fee simple, you are responsible for these costs.

Fee Simple vs. Leasehold: California

In California, it is possible to purchase property under a leasehold estate. This requires an extensive application process to the county assessor, which can be very time-consuming.

The leasehold process involves several steps:

1. The property is sold at fair market value via auction.
2. The purchaser must post a bond to protect the landlord from any future adverse financial situations.
3. The purchaser is required to pay property taxes on the proceeds of the sale and to a lesser extent, the seller’s insurance costs for the year.
4. The purchaser must obtain a certificate of occupancy from the local planning agency, which may be lengthy and expensive; furthermore, there are no exemptions from this requirement.
5. The seller is granted ninety days to re-offer the property for sale. This is not a rent-back period, but a time period in which the former owner may make a sustainable offer to re-purchase the home.
6. The purchaser must then sign an option agreement with the landlord with a deed of trust attached to it, usually for one year.
7. The purchaser and landlord must then set up permanent financing, which requires that both parties agree on loan terms such as term length, interest rate, and other terms.
8. The purchaser must obtain title insurance and a survey of the property to verify that it is free and clear of all encumbrances (purchase money mortgage, unpaid taxes).
9. The purchaser must also receive approval from the local planning department for use purposes; if no approval is obtained, the property cannot be sold or used as a residence.
10. After these steps are completed, it is possible to sell or transfer the property as an estate in fee simple.
11. If the property is transferred as an estate in fee simple, the purchaser is responsible for all taxes and fees, including homeowner dues, until the one-year option period has passed.

Common pitfalls with leasehold estates

There are several missteps that can get you into hot water:

1. If you have an existing loan secured by your leased property and you sell it to another party under a leasehold contract, the new owner may have to pay off the first mortgage before securing their own financing. This can lead to higher costs or even a complete loss of the property.
2. It is possible to lose a leasehold sale transaction because of problems beyond your control, such as a failed survey or contamination issues that could render the property unusable.
3. All improvements you make to the property are the responsibility of the lessee, including normal wear and tear on the leased land surrounding your home, not just improvements made to your home proper.
4. Even with a clean title and all of the steps described above, the property could still be foreclosed. If the previous owner owed more than the amount of the sale price, you would have to take possession back from them yourself.
5. Be very careful with leasehold sales. The borrower is released from all obligations under your lease by paying off their mortgage and then furnishes a deed for you to sign as an option agreement with your leaseholder.

If you want to lease property, go to the county clerk’s office and find out who is leasing the property. You might be able to strike up a conversation with them about their lease, which will give you some insight into what could happen if your lease were transferred.

Most importantly, be wary of anyone who wants to sell you a leasehold home. The best way to avoid this problem is to purchase fee simple land.

The bottom line

Finally, knowing the distinctions between fee simple and leasehold ownership is critical if you want to ensure that you receive your dream house and enter into a contract that is appropriate for your budget and development ambitions.

Leasehold ownership may be your sole option as a commercial investor. However, if you are a residential investor, you have a lot more possibilities. Before signing on the dotted line, conduct a lot of research and make sure you understand your ownership freedoms and restrictions.

While fee simple ownership is the most comprehensive type of ownership in real estate, it is not the only method to do business. While leasehold ownership has drawbacks, it also offers benefits in commercial real estate leasing and condo ownership.

FAQs

What is Fee Simple?

The fee simple estate is the most common and complete form of ownership in real estate. It is an absolute ownership interest in real property that lasts for the owner’s lifetime and beyond, subject to certain limitations.

The fee simple estate is the most common and complete form of ownership in real estate. It is an absolute ownership interest in real property that lasts for the owner’s lifetime and beyond, subject to certain limitations.

Land acquired in fee simple is totally owned, with no constraints or obligations. Absolute estate is a sort of infinite estate.

A fee simple is produced when a deed conveys land with no stipulations, often using language like “to John Doe” or “to John Doe and his heirs.”

What does fee simple mean when buying a house?

The phrase fee simple in real estate refers to a landowner’s complete and absolute ownership of a piece of land and any properties on it.

The fee simple owner is free to do whatever they choose with the land as long as they follow established easements and zoning rules.

The holder has the absolute right to use, control, and dispose of the property. There are no other limitations or conditions on the holder’s use of the property, other than those that may be imposed by government.

This is the most common form of ownership of real property in the United States.

Why is it called fee simple?

The term “fee” is derived from the word “fief,” which refers to a medieval landholding. When feudal land tenure was abolished, all fiefs became “simple,” with no tenancy obligations.

What does fee simple HOA mean?

Fee Simple – A Homeowner’s or Property Owner’s Association with a deed to a defined space on a distinct lot and an undivided fractional interest in the common components. Typically, common items are located on different parcels, the titles to which are held by a HOA or POA.

Which type of estate is the most desirable?

As a result of these factors, the fee simple absolute estate is the most attractive estate in residential real estate. It is also the most widely used.

The estate reverts to the prior donor. Fee simple defeasible is classified into two types: determinable and condition subsequent.

What is a leasehold on a property?

A leasehold is a form of property ownership in which the owner of a property leases the property from a landlord for a set period of time.

The tenant has exclusive use of the property during the lease period, and is responsible for all payments associated with the property, including rent, utilities, and maintenance.

At the conclusion of the lease period, the property reverts back to the landlord. Leaseholds are common in the United Kingdom and other countries with a history of leasehold property ownership.

In real estate, a leasehold is a property or land where the owner does not hold legal title but instead holds a lesser interest in the property called a lease.

The leasehold estate may be for a designated portion of the property or for the entire interest in it. The term “leasehold” is used primarily in common law jurisdictions and rarely in civil law jurisdictions.

It is different from freehold, which is ownership of land based on direct possession.

Why would anyone buy a leasehold property?

Others prefer to live in a smaller place after separating or divorcing. This is also true for elderly persons who wish to avoid the added problems and expenditures that come with owning a home for which they are solely accountable.

It is also typical for persons working in city centers to purchase leasehold homes in order to reduce travel times.

What happens after leasehold ends?

When the lease ends, the property reverts to a freehold property, which is owned by the freeholder, and you no longer have the right to occupy it.

After that period of time elapses, the ownership of the estate reverts back to the person who granted the lease in the first place. This is in contrast to a freehold estate, where the owner of the estate holds it indefinitely.

Why you shouldn’t buy a leasehold?

Buying a leasehold can present a number of problems, not the least of which is that you are renting from the landowner.

This means they have the right to evict you if they feel that your presence is affecting their ability to use their property.

Leaseholds can be subject to limitations or conditions as well. If a leaseholder cannot meet these obligations, then he or she has the right to sell their leasehold interest at a predetermined future date and you will no longer have access to it after its termination date.

How long does a leasehold last?

Leasehold indicates that you only have a lease from the freeholder (also known as the landlord) to use the residence for a set period of time.

Leases are often for a lengthy period of time, generally 90 years or 120 years, and as long as 999 years but they can also be for a short period of time, such as 40 years.

Can you get a mortgage on a leasehold?

Most mortgage lenders will not lend on homes with lease terms of less than 70 years. Lenders prefer that the lease runs for at least 40 years beyond the conclusion of your mortgage term so that the property’s value is not harmed.

What is the difference between fee simple and freehold?

A freehold estate is one in which you have the only right to occupy a property for an indefinite period of time.

A less than freehold estate, on the other hand, is owned for a certain amount of time. The largest interest in a parcel of property that one may conceivably acquire is fee simple absolute.

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