Investment or handcuffs: Issues to do with Buying Property in New Zealand
By Peter Micevski, construction and planning lawyer, Lovegrove Smith & Cotton
co-authored by Stephen Smith
Auckland is one of the hottest property markets in the world at the moment. This is largely due to the lack of stamp duty that new purchases attract, but also due to the high net levels of immigration into Auckland. Throughout the times most Kiwi property owners have aspired to own both the house and the land (known as “freehold” or “fee simple” property). However with the net migration into Auckland climbing and continuing to climb, the boost to population has had and will continue to have implications for housing demand throughout the city. This may mean that owning your own property (including the house and the land) is a thing of the past.
Indeed in recent times we have acted for property investors in New Zealand that have shifted away from the conventional method of purchasing property (i.e. purchasing freehold property) and opted for the cheaper alternative, leasehold property. The market has also reflected this shift, as approximately 15% of the central city apartments in Auckland are thought to be on leasehold land. Whilst in Australia the concept of buying leasehold property is relatively unknown, in New Zealand it is the only way some people can buy into houses.
Leasehold is an ownership of temporary right to hold land or property in which a lessee holds rights of real property by some form of title from a lessor or landlord (i.e. the freehold property owner). Ordinarily, a lease will be in place with the landlord that will determine how many years you can live in the property, generally these leases extend 70-90 years if not more. During this time, you own the property but not the land it stands on. Thus you are required to pay ground rental fees for the land to the landlord, and at the end of the lease the ownership of the property will theoretically revert to the landlord.
In a city where freehold apartments cost about 300% more than leasehold apartments, the allure of leasehold is easy to see. However, as we have come to appreciate, some leaseholds can be dangerous beasts and they are not as clear cut as they seem. As we will explain, by purchasing leasehold you may be buying yourself a rental property with handcuffs.
Depending on the lease, the annual ground rent is subject to review every seven or 21 years. Rent reviews are usually based on a fixed percentage of the land value. Given Auckland’s soaring land prices, this means that rent reviews can be a shock.
We are familiar with a matter where a property investor invested in a two bedroom apartment in an apartment complex on Maori land in Auckland. The investor purchased the leasehold some years ago for nearly $400,000. At that time the annual ground rent was $3,000 p.a. ($57.69 per week). Since then the ground rent has ratcheted up to over $10,000 p.a., approximately 340% greater than when the investor purchased the property. To add to the investor’s woes, the value of the leasehold has plummeted by a very long percentage.
Unfortunately this is not uncommon and in recent times Auckland has seen many leasehold property owners abandon their leasehold properties due to excessive rises in annual ground rents. Details have emerged from a recent High Court matter where eight leaseholders abandoned their leasehold properties due to massive new ground rents. In those scenarios, annual ground rent shot from $8,300 p.a. to $73,750 p.a.
Note also that in many instances (if not all) leaseholders have borrowed money from a bank to finance their leasehold and are required to service their loan each month. To add to that expense, many leaseholders are required to pay Owners Corporation fees (specifically if the leasehold is in an apartment complex) and not to mention they are also required to carry out repairs, renovations and improvements as necessary. After coupling up each expense at the end of the month, it is difficult to see whether, if at all, any pennies will be remaining.
Thus when there is a dramatic increase in the annual ground rent after 7 years, it is obvious how a leasehold property owner has the potential to quickly become financially crippled. Anecdotally, we have noted that leasehold investors are looking to terminate and/or at the extreme abandon their leasehold due to increases in the annual ground rent.
Let’s take this as an example: an investor secures a loan with a large retail financial institution to purchase a leasehold apartment on Maori land. At the time of purchase, the loan is approximately $200,000 with an interest rate of roughly 7% p.a. To add to that, the investor is required to pay $3,000 p.a. in annual ground rent and approximately $6,000-12,000 p.a. for Owners Corporation fees. In total the investor is required to pay at the least $23,000 a year to own the leasehold. If the investor is able to rent out the premises for approximately $400 per week, the investor will yield approximately $20,800 a year in rent. The investment is hardly sound from the outset.
Then after 7 years, there is a review of annual ground rent and the investor is required to pay $10,000 p.a. in annual ground rent. Further, the investor must contribute approximately $6,000-12,000 p.a. in Owners Corporation fees, and approximately $14,000 in mortgage repayments, bringing the total cost to own the leasehold to at the least $30,000 p.a. Instead of reducing the cost of owning property with time, as ordinarily is the case with investments, the investor will be forced to pay a significant amount more per annum without in fact reducing his/her indebtedness to the financial institution.
God forbid, if the investor loses his/her job and can no longer continue to pay ground rent fees, the investor will be in risk of losing the land to the freehold property owner and left with a substantial loan from a financial institution with no substantial assets to realise to reduce the debt. Unlike in some other countries around the world where some debtors can choose to “walk-away” from their debt, in the Antipodes, the financial institutions are at liberty to utilise the judicial system to ensure that the loan agreements from the debtors are enforced against the individual and can visit all losses upon the respondent. In some instances, unless the recalcitrant pays, the financial instiutions may lead the debtor into bankruptcy.
Whilst financial institutions are now reluctant to lend against leasehold property, there is a place for leasehold, particularly with Chinese buyers who are familiar with the concept. However, we urge anyone that is considering purchasing leasehold, that they obtain competent legal advice to ensure that they are fully informed about their rights and responsibilities under the lease. This method of owning property may indeed be a method for purchasing your own financial incarceration mechanism.
By Peter Micevski, Lawyer, Lovegrove Smith & Cotton
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