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Leasehold at expiry

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asked Sep 11 in BUS 4027W - Actuarial Risk Management by rohin_jain (790 points)

Hi there

Suppose I am a leaseholder of some land (there is no development on this land). I decide to build it up and run my business on this land. I have increased the value of this property. At the end of the leasehold term, I am required to return the land to the freeholder (as per lease agreement). 

However, I have increased the value of the property to the freeholder. Is there some sort of compensation the freeholder should pay me for increasing the value of the freeholder's property?

I also understand that at the end of the leasehold there is something called the "reversion of freehold". To my understanding, this is an amount the leaseholder can pay the freeholder at the end of the lease agreement in order to become the new freeholder? Is this correct?

1 Answer

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answered Sep 18 by jolegutko (740 points)

So you have leased an unencumbered property. I think that if this is a short leasehold, then you would either not build on it at all, or if you do make the stuff collapsible and movable. I don't think that leasing a property in the short term, and then investing in its development, is a normal thing.

So if it is a short lease, and you need to make adjustments to the property, you would negotiate this with the owner upfront. I think this would typically be a request from you to the owner to alter the property (presumably in exchage for higher rent). In some cases, it is understood that the tennant will alter the property at their own cost (e.g. renting a shop in a mall) and then that's just an extra cost to the tennant.

If it is a very long (99+ years) lease, then you might want to invest in developing it. The key is, when you sell the lease later, the new owner of the lease will compensate you for the hardware, as it were. Of course, as the lease runs its course, the willingness of the new tennant to pay will too, so there is some attrition of value - but the stuff will also be getting old, and may not be being upgraded as tennants are increasingly seeing this as a short lease.

I don't think that the freeholder pays for the leaseholder increasing the value of the property unless this is very specifically negotiated. Remember also that for commercial property, the function of the land will change often, so all that work done by one leaseholder is not necessarily improvement in the eyes of the freeholder ("we'll have to demolish all this rubbish so that we can lease this to a nice chemical plant next").

Finally, the reversion of freehold in the notes refers to the reversion of the unencumbered freehold to the owner. I.e. if you buy a freehold that is leased, what you are getting is the rental payments, plus the "unencumbered freehold" at the end of the lease. make sense?

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