Client Question: What is the difference between Fee Simple Interest and Leasehold Interest and which one is best?
This questions can be answered in several different ways depending on the investors objective and needs. Typically investors like triple net properties is because of the lower risks and conservative yields. With these different types of ways you can own a property the yields and risk can vary.
Fee Simple single tenant net lease investments typically are lower risk and conservative yield. The most common form of ownership is fee simple, this is the case when a investor takes title to the land and the building. From that point the investor is seeking a stable, high corporate guaranteed credit-rating tenant and the yield can vary depending on the particular type of tenant and location.
Investors also have another type of ownership which is leasehold interest which lead to a higher yield. Deals like this may not be fortune 500 tenants, that often carry a Moody’s or S&P BB credit rating or better. Most tend
to be medium size regional companies but serve as solid tenants and depending on the lease term deliver cap rates from 7.5% to over 12%. Some but not many national tenants do rent from leasehold interest investors, some of those tenants are Advance Auto Parts, Lowes, Walgreens, Trader Joe’s and Safeway.
With leasehold interest the investor does not own the land and building but have the long term right to lease the property to a tenant. In this situation you are serving as both the landlord and the tenant. At the end of the lease term the building and the land reverts back to the original land owner.
The big difference between fee simple and leasehold interest is that with leasehold you are collecting the net rent amount less the ground rent, which is paid to the original owner. With a fee simple, you own both the land and building, therefore you collect all the incoming rent. At the end of the term, the investor’s leasehold interest and right to collect rents ends. Investors tend to consider leasehold interest deals as a form of a bond or cash annuity which are predicted rate of return, though not completely risk free. The risk of a tenant not exercising their renewal is a possibility as the property reverts back to the land owner at the end of the lease term and there may not be enough time to replace the equivalent cash flow.
Leasehold interest are a good idea for investors if their strategy is:
- To get a higher return
- To diversify by tenant and risk
- The investor wants the ability to sell the leasehold interest to another buyer during the life of the lease term.
- To take advantage of tax strategies
- Wants to walk away from the asset at the end of the lease and not be responsible for re-leasing it
Whatever objective you have our goal is to assist you in considering what the best strategy for your particular situation. If you have any questions or would like to discuss your investment strategy feel free to contact us.
Dwaine Clarke is a published author and founder of Clarke & Tinker Net Leased Property Group, a commercial real estate sales and advisory firm located in Connecticut. Connect with Dwaine on Twitter and Linkedin