Have you ever considered buying a note secured by property on leased land? This interesting arrangement is actually more common than you might think. Before you make assumptions about what this would mean or whether or not it’s a good idea, consider the pros and cons of a note secured by property on leased land.
To make sure we are on the same page, what exactly does property on leased land mean? This purchase arrangement can happen under several different common scenarios. Basically, it means you purchase a home or building, but the land is leased. Typically leases on these types of properties run for 50 or even 100 years. Some places you may frequently see this arrangement are in condos, townhouses and trailer parks.
From a note investor’s perspective, the pros of buying a note secured by a property on leased land are few. The biggest factors that make buying a note secured by a property on leased land attractive are that
- The lease fees the payor pays may include maintenance of the property, freeing you from tasks such as mowing the lawn or gardening. So, we can be fairly comfortable the property will be well maintained (at least on the outside).
- The payor may avoid property taxes unless it is stated differently in the lease. Since the buyer of the property (payor on the note) doesn’t actually own the land, they may not be held responsible for the taxes on the property. That lowers their annual expenses which might be a good thing. However, if you really think about it this can be a con as well if the Lessor’s fail to make the property tax payments.
From the same Note investor’s perspective, there are some significant drawbacks that may make you reconsider purchasing a note secured by property on leased land. Principally, the fact that by the payor not owning the land the property is on can lead to complications and unpleasant surprises down the line. Of course, if you do your due diligence and investigate in detail, you can avoid some of these issues. However, the truth remains that owning a note secured by property on leased land means that decisions about the property lie in the hands of others. Here are some more specific cons of buying a note secured by property on leased land:
- The property is often cheaper than when the payor owns the land and that may affect the quality of the note payors. A person can own a home, townhouse or condo on leased land for much less than similar options on purchased land.
- Using this arrangement can allow a buyer (payor) to purchase a property in areas where prices would be prohibitive otherwise meaning they may not actually be able to afford the property or the payments that go along with it.
- The Payor has to pay lease or rental fees on the land. This means that although the payor’s note and mortgage payment may be lower, the land lease may add a significant monthly or yearly payment. Be sure to compare this cost with the property taxes you’d pay when purchasing a property with land so that you can figure out what the real expenses are for the payor. Also, keep in mind that if the lease expires and the payor is able to renew it, the lease costs may be renegotiated at an increased rate due to inflation and other factors.
- If you’re purchasing a note on a condo or townhouse on leased land, Homeowners Association (HOA) fees may also apply. These fees go towards covering maintenance of shared amenities such as a pool, tennis courts, gardening services, gyms, etc. which adds more expense for the payor every month.
- Even in a rising real estate market, equity in the property will not build at the same rate when comparing properties on leased land versus the way it would in a traditional purchase. Why? Because the value of a property typically depreciates over time. This is especially the case in leased land properties because the lease time shortens. While other homes may grow in value because of rising land costs in some communities, the rising land costs negatively affect a leased land situation because it implicates a higher rent.
- Another con to buying a note secured by a property on leased land is that it may be more challenging to find another note investor should you decide to sell the note in the future.
- If the payor wanted to refinance and pay you off finding a lender to provide them with a loan can be more challenging in a leased land property than with a traditional purchase.
- Lastly, in terms of note position, a Land Lease is usually the senior lien on the title to the property. In translation, it might look like you are trying to purchase a note in first position but when buying a note secured by a property on leased land, the note is technically in a secondary or junior position.
As you can see, there are many cons to purchasing a note secured by a property on leased land. However, it really does come down to you and your unique situation. For some people, this arrangement makes perfect sense and can be a wonderful opportunity to buy a good note. Others may evaluate the situation differently and choose to not by notes that are secured by property on leased land.
Buying a note is a big investment and requires careful detailed due diligence. Now, with this list of pros and cons, I hope you feel more prepared to make your decision about whether to purchase a note secured by a property on leased land. Be kind, keep safe and stay healthy. Remember success demands action, keep on marketing, it’s going to work! TWITA! (That’s What I’m Talkin’ About!)
Jeff Armstrong of Armstrong Capital has been a note investor and broker specializing in the performing seller financed note industry since 1991. For more updated and current information on how he can help you with your note business, note investments, note appraisals or to request pricing options on a note visit www.armstrongcapital.com to email him and subscribe to Jeff’s Weekly Training & Tips Newsletter.