Property report: Ground rent needs cautious approach

Leasehold titles are common for upmarket waterfront apartments. Photo / Doug Sherring

Leasehold properties have a tarnished image but can still suit some homeowners and investors. Tony Verdon reports.

Most New Zealanders run a mile when they come across leasehold land, fearing a horror story of huge ground rent increases and a mountain of uncertainty.

But although leasehold property in this country has a somewhat chequered history there are circumstances where leasehold properties provide an attractive option.

This country has four main forms of land ownership, the most common being freehold titles where the title-holder owns the land and the house, apartment or buildings on the land.

On leasehold land someone else owns the land, but the leaseholder has the right to live in the house or building on the land. The leaseholder must also pay the owner of the land, or lessor, ground rent.

It is the length of leases and the ground rental portion of lease agreements which has generated the most controversy in recent years. For decades, when land prices were relatively stable, ground rental reviews resulted in relatively modest rental increases. In most leasehold agreements the ground rental is based on the freehold value of the land.

In many leasehold agreements the ground rental is set at 5 to 7 per cent of the freehold value of the land.

But with soaring land prices, particularly in the past two decades, ground rental reviews have resulted in huge, in some cases crippling, increases in ground rent fees. The problem has been compounded by ground rental concessions being granted to help get some major apartment block projects under way, with the first buyers enjoying relatively light ground rents. Complicating the history of leasehold land in Auckland, in particular, is the fact some apartments were bought a decade ago at the peak of the property boom and sold at market premium prices.

Leasehold ground rental reviews are often timed for seven-year intervals, and owners of some Auckland leasehold apartments have been shocked to find their annual ground rent trebling overnight.

As an example there are Auckland leasehold property owners who have had to deal with ground rental increasing from $10,000 a year to $30,000.

This should come as no surprise to leaseholders who live here -- after all, QV figures show Auckland property prices are now 39.4 per cent higher than the previous peak. Much of this increase is the value of the land increasing rather than the property sitting on it.

The quandary for some foreign investors, particularly Australians unfamiliar with leasehold titles, is that the market value of their investment apartments has slumped at a time when prices have soared. The reason for the slump: potential buyers' reluctance to take on leasehold property, because of the uncertainty of ground rental levels.

The lesson, say property investors, is to take expert advice and research potential purchases thoroughly before committing to buy.

Although all potential property buyers should take legal advice before committing to a purchase the complexity of lease agreements makes legal advice even more vital to avoid later shocks. But there are buyer circumstances where, despite potential future uncertainties, a leasehold agreement would make sense.

Of the more than 20,000 apartments in central Auckland, more than 3000 are on leasehold titles.

More than half of these are in desirable waterfront or near-waterfront areas, such as the Beach Rd area, along The Strand and on Quay St, in more than 10 large apartment buildings.

There are also leasehold apartments in the Viaduct Basin, in the Beaumont Quarter (although many of these have been converted to freehold), near the top end of Queen St, and in Symonds St.

And like every aspect of real estate, each agreement and arrangement can be different so it is wrong to dismiss leasehold properties as a whole, either as a home or investment opportunity.

But real estate agents say investors looking for strong capital gain should probably opt for freehold property.

However, potential buyers looking to use their funds to develop a business, for example, may find the leasehold option more attractive.

Their initial purchase price can be as low as a third of the equivalent freehold property, meaning they can enjoy living or leasing an apartment for $200,000 to $250,000 compared with $600,000 to $650,000 for a freehold equivalent.

The downside is higher continuing ground rent payments plus the potential of these increasing after the set rental review.

Real estate agents say leasehold apartments attract buyers from China, because they are more familiar with the concept of leasehold property than most New Zealand residents. There are also efforts to try to reduce the uncertainty about future rental price increases.

Waterfront Auckland has structured leasehold deals in the Wynyard Quarter where apartment owners can pre-pay ground rent for 125 years.

Under the deals being offered by apartment developers, buyers can pre-pay the ground rent, and the term of the lease is longer than most lease deals to accommodate one and possibly two or more ownership cycles.

When the lease nears the 125-year point, the apartment owners have the chance of negotiating a new lease on terms agreed, on the market terms existing at that time.

The pre-payment price is based on the value of all forecast future annual ground rental payments for the period, including reviews.

Waterfront Auckland has signed an agreement with developer Willis Bond to build 500 to 600 apartments, townhouses and duplexes in the Wynyard Quarter over the next eight to 10 years.

The properties will house 1100 people in 17 buildings, with the first homes becoming available in 2017.