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Mumbai realty: Evaluating leasehold and freehold land

The developer ordinarily pays a substantial value for the long-term lease to the lessor up front.

Written by Ramesh Nair |
November 16, 2013 11:13:55 pm

A leasehold property defines the status of the land on which the property is built. Leasehold land on which construction takes place is ordinarily on long-term lease,which may be between 30 to 999 years. Specific to residential property on leasehold land,one may use the example of the MMRDA’s Wadala development plan,wherein the land is given on long-term lease to developers who can sell the units constructed on an outright basis.

The developer ordinarily pays a substantial value for the long-term lease to the lessor up front. A few examples of such lease hold properties are the collector’s land on which Nariman Point stands,Mumbai Port Trust lands in Masjid Bandar and Ballard Estate,and Navi Mumbai as well.

On completion of the project,the lease is transferred in the name of the society formed. The future of such properties after the lease term is uncertain to the extent of the amount that the state demands for renewal,which will need to be paid by the society.

Clarity on this is expected after the legal authorities reach a decision on the Nariman Point buildings,wherein renewal is imminent. A concrete formula is expected with respect to calculating the incremental value required to be paid by the societies for renewal.

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How does it matter whether a property is leasehold or freehold? It should be remembered that in the case of a freehold property,the owner retains complete legal rights over the property indefinitely.

However,a person or entity is legally entitled to occupy or use a leasehold property only for a specified period,on the basis of rental consideration. Once this period expires,all legal rights pertaining to occupancy and use of the property return to the owner. Also in case of any transactions on this land by the lessee an NOC is required from the lessor.

If a property is built on leasehold land,selling it can become a major issue if the term on the leasehold land is due to expire. Any person seeking to purchase such a property would find it extremely challenging to obtain a home loan for this purpose. The remaining lease duration is fundamental for home loan approvals. Ordinarily lease durations of 99 years and beyond do not face many issues. Since it is not always possible to opt for a freehold property,it makes sense to understand the advantages and disadvantages of freehold versus leasehold properties.

Advantages

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u Relatively cheaper prices (subject to the lease duration offered),as the land cost to the developer may be less than that of buying land outright in a similar location. In other words,a good location at lower cost but for a shorter duration.

u Usually,this arrangement is part of larger,well-planned developments which provides certainty of sound locational attributes and planned infrastructure support.

u Developers are ordinarily bound by certain timeline commitments towards the lessor,ensuring the interests of owners. A good example is the plots at Bandra Kurla Complex and CIDCO leases.

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u A plot with clear title (as the owners are ordinarily large government bodies with all required proofs),thorough due diligence is done and developer credentials are also intricately verified.

Disadvantages

u Uncertainty after the lease tenure.

u Possible additional and substantial liabilities in the future on renewal of the lease.

u Possible devaluation of the property as the end of the lease term draws close.

u Possible transfer charges levied by the lessor on any transactions in the premises.

Developer Perspective

A developer is most concerned about costs incurred,so they may prefer to build on leasehold land as the land cost may be lower than that of freehold land,and not all of this cost benefit is passed on to the buyer. Land cost in premium locations is invariably the most significant cost,so any savings on this front are highly preferable.

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Leasehold options,however,create a lot more inflexibility for the developer in terms of requiring to continuously revert to the lessor for permissions etc. and even in cases wherein they wish to utilise transfer of development rights (TDR) it is an obstacle.

In most residential developments,the developer will have completed all tasks and responsibilities associated with the plot long before renewal is due,and will have already exited the premises. Therefore, he is not concerned with whatever transpires after that. It is true that it is harder for developer to leverage the land for funds initially (in case of leases shorter than 99 years particularly),but the leasehold route may still be more preferable in case substantial cost savings are envisaged.

Buyer Perspective

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Given a choice in case of residential options particularly — and if the budget permits — it is definitely preferable to invest in a freehold alternative,given the better clarity on the future. It is also easier to leverage a freehold property to procure funds in case of future requirements.

The author is COO – Business,Jones Lang LaSalle India

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First published on: 16-11-2013 at 11:13:55 pm

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