Leasehold - everything you need to know (part 1/3):
What is a leasehold? What are the advantages and disadvantages? Who grants it? How do you finance ground leases? What special considerations need to be taken into account? Is the ground rent tax-deductible? Does land transfer tax apply? We answer the most frequently asked questions.
What is a leasehold?
Leasehold is one of the rights equivalent to real property. The basic idea is to reduce the costs of building a home by not buying the land on which the property is to be built, but "renting" it for a longer period (usually 99 years). The instalment to be paid by the leaseholder to the landowner is called ground rent. To simplify, you can think of the leaseholders as tenants and the landlords as landlords.
What are the advantages of leasehold?
The advantages of leasehold can be summarised as follows:
1. it reduces the purchase price of real estate and makes the dream of owning a home accessible to a wider target group.
2. by eliminating the purchase price of the land, the equity ratio for the planned building project increases. As a result, banks can grant better loan conditions than with the conventional construction of a new property.
3. in sought-after locations, it is sometimes the only possibility to obtain building plots.
4. church sponsors in particular often grant families preferential conditions.
5. land prices have risen significantly more than consumer prices in the last 15 years. Since value retention clauses are based on the latter - and not on the market value of the land - there is a price advantage compared to the usual rent.
6. advantages in depreciation for landlords, as the ground rent can be recognised as income-related expenses.
What are the disadvantages of leasehold?
1. no permanent ownership is established
2. profit from land appreciation remains with the owner and not with the leaseholder
3. compensation for residential buildings at the end of the term ("reversion") is usually only 2/3 of the building value
4. in times of low interest rates, the leasehold is not very profitable for the beneficiary. Instead, a loan can be taken out for a mostly lower interest rate in order to establish permanent ownership.
Can a leasehold be resold, mortgaged or inherited?
The equation of leaseholders as tenants and leaseholders as landlords is simplistic, since the leasehold as a right equivalent to real property is similar to "ownership for a fixed term". Unlike a tenancy agreement, the leasehold can therefore be resold, mortgaged, inherited or even sold at compulsory auction. Special features of the heritable building right contract with regard to sale and mortgaging may have to be observed.
What happens at the end of the leasehold term?
Since the constructed building belongs to the "tenant", but the land belongs to the "landlord", the question arises as to what happens at the end of the leasehold term. At the end of the term, the property becomes the property of the leaseholder in return for a compensation payment to the leaseholder - usually 2/3 of the current value of the building.
How long is the term of a leasehold?
The term of a leasehold is freely negotiable. Usually it is between 75 and (mostly) 99 years for flats and single-family houses. In the commercial context, shorter terms of between 30 and 60 years are common. However, there is no legal restriction, so perpetual leasehold is also permissible. A longer term is always in the interest of the leaseholder.
Is there a difference between leasehold and Emphyteutic lease?
The leasehold is to be distinguished from the often colloquially mentioned Emphyteutic lease. Emphyteutic lease developed from the feudal system and is a right to use agricultural land; it has been prohibited since 1947. Leasehold mostly concerns single-family houses, but can also be found in condominiums and commercially used properties.
How do I recognise a property with a leasehold?
A leasehold is a right to a property and is recorded in Section II of the land register, just like rights of way, rights of way and residential rights. To establish the leasehold, a leasehold contract is concluded between the grantor of the leasehold and the leaseholder. A leasehold land register is created for the leasehold in the same way as the land register.
Can leaseholds be subdivided?
Land can only be encumbered with a leasehold as a whole - this is clear from §1 para. 1 ErbbauRG. As a right equivalent to real property, heritable building owners can freely dispose of the right (or the land) - as long as it does not conflict with the heritable building contract. They can not only sell the right but also subdivide it in accordance with the German Residential Property Act (WEG) or by means of sub- heritable building rights.
Subdivision of the leasehold according to the WEG
In the case of a subdivision by means of a subdivide building right - analogous to the establishment of part ownership - a separate land register sheet is created for each part ownership unit. Legally, the subdivision is also regulated according to the Condominium Act (WEG). For the declarations of partition, standard templates can be used as usual with minor adjustments - e.g. replacing the word "owner" with "heritable building owners".
In summary, this means: A (further divisible) leasehold always extends to the entire property. This avoids that, for example, co-owner A of a residential unit in an apartment building owns the ground while co-owner B merely "rents" the ground share in the leasehold. The subdivision of a leasehold is thus possible without any problems; however, it always applies equally to all co-owners.
Subdivision by means of sub-leaseholds
For example, there are two ways to build on a large plot of land with several detached houses under a leasehold: One solution is to first subdivide the large plot of land in order to encumber the smaller plots individually with leaseholds. An alternative to subdividing the plot is to subdivide a leasehold on the entire plot. This subdivides the so-called "Obererbbaurecht" into "Untererbbaurecht".
What other forms of leasehold exist?
In addition to the division in accordance with the WEG and the division into subdivisions of leaseholds, there are two forms of unification of leaseholds: Under certain conditions it is possible to create an overall heritable building right. An overall leasehold is a single leasehold which extends over several plots of land.
Furthermore, there is a so-called "neighbouring building right", whereby the admissibility is controversially discussed. In a neighbouring leasehold, a single, indivisible building is erected over several plots of land, whereby the plots of land themselves are encumbered by different, independent leaseholds.
What should be considered when mortgaging leaseholds?
In principle, leaseholds can be mortgaged just like real estate. Since it is used to secure financing, the remaining term at the time of lending should be at least 30 years. The last instalment of the mortgage must be repaid 10 years before the leasehold expires in accordance with §20 paragraph 3 of the Leasehold Act (Erbbaurechtsgesetz).
Is the ground rent apportionable or tax deductible?
The ground rent is not apportionable to tenants via the ancillary costs. Corresponding to the land price in the case of a purchase, it is not considered an operating cost. However, it is tax-deductible for landlords and can be claimed as income-related expenses. In this respect, the deductibility differs in comparison to full ownership of the land, which cannot be depreciated. This takes into account the fact that the land is only a temporary property.
Who grants leaseholds?
The largest providers of heritable building rights in Germany have traditionally been the churches and municipalities. Thus, after the war, leaseholds were increasingly issued to counteract the acute housing shortage and to grant a larger section of society the chance to build residential property. In many municipalities, e.g. also in Langenfeld, it is customary that those with hereditary building rights can also purchase the property later. To a lesser extent, leaseholds are still granted by the real estate offices today, for example in Düsseldorf's Behringweg, where the award is made to private building communities. In the Düsseldorf area, as a result of the rapid rise in land prices, (private) housing associations have also been increasingly found among the grantors of heritable building rights recently, e.g. in Rabenstraße in Monheim. Since the granting of leaseholds is the responsibility of the municipalities, the offers vary greatly from region to region. In Hilden, for example, there are hardly any municipal leaseholds to be found.
Is land transfer tax payable on leaseholds?
Land transfer tax is payable on the establishment or sale of a leasehold. However, since leaseholders do not become owners of the land, this is not calculated on the basis of the purchase price but on the ground rent payable and the remaining term. The maximum multiplier of the annual ground rent for calculating the assessment basis is 18.6. An overview of the multipliers can be found here (German).
Calculation example 1: Land transfer tax for a leasehold in Düsseldorf
If a leasehold is sold with a quarterly ground rent of 1000 € and a remaining term of 60 years, the land tax to be paid is calculated as follows:
Quarterly ground rent: 1000 €
Annual ground rent: 4000 €
Multiplier according to Annex 9a BewG: 17.93
Assessment basis for taxation: 17.93 * 4000 = 71,720 €
Tax rate for land transfer tax in NRW: 6.5%.
Land transfer tax to be paid: 4661,80 €
Is a leasehold investment worthwhile?
In times of low interest rates, leaseholds often no longer make sense. Instead of promoting the construction of affordable homes, ground leases are sometimes used as a lucrative and almost risk-free capital investment.
The average ground rent rate is 3.5% for detached and semi-detached houses and condominiums in Düsseldorf, according to the local appraisal committee. Despite the prolonged period of low interest rates, ground rent rates have declined only slowly in recent years, as a short-term period of low interest rates was always assumed. As a result of the high inflation rates in 2022, a further reduction does not appear likely.
For an owner-occupied single-family house, financing (as of June 2022) can be realised at an effective annual interest rate of around 2.5% plus 1% repayment. This already takes into account the recent rise in interest rates, which will probably continue in the future. In the past, it was also possible to obtain financing at much more favourable conditions. It turns out that at present a plot of land can be bought just as well, since the costs for financing including repayment correspond to the payment of the ground rent. For an owner-occupied home, there is no deductibility of the ground rent as income-related expenses and only a reduction of the land transfer tax by 2 percentage points. In return, a leasehold, which has a lower value than a full ownership, is acquired.
Should interest rates continue to rise in the future, a comeback of the leasehold is to be expected. It is also a state instrument of land policy. If it is used in the long term, it can sustainably strengthen the scope for municipalities to provide land for general public services in the future.
Do you have any further questions?
Contact us and we will be happy to advise you.
Dr Paul Sobota | Expert for Real Estate Valuation
+49 176 55 66 2343
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