Leasehold versus Freehold and Urban Rejuvenation

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

October 2006

In most western countries and developed economies, land tenure is generally in freehold basis i.e. the land is eternally owned by the owner until he or she or heirs thereof sells it or when the land is legitimately repossessed according to some expropriation laws which in most cases would mean monetary compensation to the owner. However, in many developing economies and even in some developed economies such as Hong Kong, land tenure is mostly in leasehold basis i.e. the land is only leased to the user for a specific period of time. Possession passes back to the owner, in most cases the government authorities, technically without compensation when the lease is up unless the lease is mutually extended. Naturally, governing authorities need to consider other societal implications than just land repossessions in a leasehold system.  

These two land tenure bases (should) lead hypothetically not only to different contemplations for land prices and values but also to probably different modes and paces of urban (re)development. In a very broad brush way, these are the commonly perceived features for freehold and leasehold tenures: 

1)      Freehold = at any point in time, the land price or value obtained from the market will reflect the maximum possible for the given allowable use, density, and location etc under the then economic, social, demographic, political, administrative, cultural, and the like conditions, market sentiment, and future expectation. Absentee landlords are not uncommon e.g. heirs to the land may not be resident there and land reassemblies for urban redevelopment purposes are not only challenging but are also time-consuming and costly. Even if there are expropriation laws, such are exercised cautiously and sparingly with checks and balances, not to mention political considerations and potentially significant financial compensations at times, by the governing authorities.  As such, and from a more financial angle, not only has the expropriated land be underutilized, it has for starters to be SO underutilized that its best possible use minus its existing use would still leave a huge surplus to pay off the owner(s) and entice them to vacate the land. There is also the impression that freehold owners will take better care of the land and the chattels (buildings) on it compared to leaseholders.

 

2)      Leasehold = given all things being the same, the land price or value on the same piece of land on a leasehold basis should be rationally lower than the one estimated on a freehold basis. Also, urban rejuvenations could be easier and faster even if there are absentee users as the governing authorities can simply wait out the remaining lease terms and repossess the land at expiry. Also, compensations to users would be lower even in the event expropriations are carried out as users are compensated only for the remaining term in the leases. According to some valuation experts, any lease term above 50 or 60 years is as good as eternal ownership, which in turn means a remaining lease term of 20 years should not carry a value equal to eternal ownership. Leaseholders are also not expected to spend lavishly on land and building maintenance as any sunk costs are not quite retrievable.  

However, barring formal researches and further studies, the above does not always appear to jive with some of the market observations

A)     Hong Kong = all land is leasehold except for Saint Johns Cathedral and most land has a (practical) lease life expectation of up to 2047 i.e. some 41 years from now i.e. technically less than eternal. Some commentators expect lease continuity after 2047 for most leases but this is not a formally stated policy yet. Nonetheless, land and real estate are bought and sold as if they were eternal and valuations seldom make adjustments for spent lease periods. Also, land expropriations and land reassemblies are just as difficult, time-consuming, and costly, if not more, than jurisdictions working on a freehold basis. Compensations for expropriated land do not appear to take the remaining lease term into much consideration either. Perhaps there are other societal and administrative factors at play which render the leasehold basis ineffectual or less significant.

 

B)     Developing economies = offer leaseholds with limited terms, e.g. in the case of China, ranging from 40 to 70 years. Nonetheless, real estate investors do not appear to have always taken comprehensive account of such time restrictions. Whether this is out of neglect or is due to some expectation of lease continuity (via land rents or an upfront extension fee remains to be seen even if one assumes this route to apply in future) is another question. Perhaps there will be societal and administrative aspects to contemplate by the time lease renewals are required. Despite this, urban redevelopments do appear to take a much faster pace in several developing economies.  

By no means is this article projecting or predicting any societal or administrative trends for some economies with leasehold systems. We simply do not know. It is just that investors may need to take a bit more notice of the land tenure basis and in a leasehold system to pay a bit more attention to the remaining lease term. A nightmarish scenario would be for an investor to have paid for a piece of land as if it was to be eternally possessed yet which authorities intend to repossess upon expiry. This might not be so bad if the term is 50 years or more (as if eternal) yet one needs to be careful if the remaining term is say 30 years or less. From a pure financial angle, the repossession may not be exercised or too executable if the highest and best possible use at the time is not much higher or is even on par (or lower than?) with the then existing use and status.  

 

*This article is inspired by a conversation your humble author has had with an industry expert.

Notes: The article and/or content contained herein are for general reference only and are not meant to substitute for proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.                   

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