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What is leasehold?

Leasehold is the right to build and maintain your own building on a third-party property. In return for this right, the payment of a ground rent to the owner of the land is due. The land does not become the property of the owner, but may only be used for the development of a property.

How leasehold can be used for investment

Leasehold can be an interesting investment opportunity- and a good alternative to the currently unattractive bond market. It generates ongoing income over a long period of time. With leasehold, you invest in a tangible asset that is secured by the land register. In this way, you benefit from ongoing value protection without having to bear the typical risks of real estate.

On which laws is leasehold based?

In Germany, ground leases are regulated by the Erbbaurechtsgesetz (German Ground Rent Act) of 15 January 1919. On November 30, 2007, the Erbbaurechtsverordnung (ErbbauVO) was renamed Erbbaurechtsgesetz (ErbbauRG).

When does the leasehold end?

How many years the leasehold contract is valid is freely negotiable between the owner of the land and the person entitled to the leasehold. The usual term is 99 years. The leasehold can be sold and inherited, as it is a right equivalent to real property. Structural changes to the property, a sale or further encumbrances can only be made with the consent of the property owner. If the leasehold agreement ends after the agreed term, the owner of the land is obliged to pay the leaseholder appropriate compensation for the property. As a rule, this amounts to two thirds of the current market value. If the ground lease contract ends and the owner of the land is not able to pay an appropriate compensation for the value of the property, he must give the ground lease holder the opportunity to extend the ground lease contract. In this case, of course, no compensation is due for the building located on the property. If the leaseholder objects to an extension, the owner of the land is also not obliged to pay.

How does an investment in leasehold work?

The principle of leasehold works as follows: The investor and land plot owner grants the building owner the right to use his land plot in return for payment of a ground rent. As a rule, this ground rent is a percentage of the current land value. All costs and risks - such as maintenance costs, property tax and possible vacancies - are borne from this point on by the person entitled to the building lease, who is the owner of the building. The property owner is not liable for this.

How safe is the investment in leasehold properties?

If the leaseholder is no longer able to meet his interest payments, the investor holds the land plot as a tangible asset and can also make use of the building on it. It is important here that the heritable building right is registered first in the land register and thus stands before all other creditors - such as banks. The entry in the land register makes the investment in a leasehold very secure for the land owner.

How are investments in leasehold taxed?

Taxation is one of the great advantages of the ground lease for investors, because it is not subject to sales tax. However, the creation or transfer of the ground lease is subject to land transfer tax. The taxable value of a leaseholder is determined in accordance with the valuation law for inheritance and gift tax and land transfer tax. Avoiding inflation by investing in leaseholder. Since the ground rents are regularly and automatically adjusted to the consumer price index this type of investment offers real protection against inflation. What return does an investment in leaseholds offer? With a balanced risk/reward ratio, an annual return of four percent plus a corresponding compensation for inflation can be expected. Calculated over a period of 10 years, a return (after costs) of about six percent per year can be achieved. 

What do ground lease holders need to consider?

For house builders, the ground lease can be a favourable alternative to land ownership. The ground rent that has to be paid to the owner is often lower than the interest that has to be paid for a loan. If the land is already built on with a property, the purchase price is usually also lower than would be the case with a building on a freehold plot. When it comes to financing construction, ground lease holders should pay particular attention to the following three points:

  • The ground rent for the property must be considered in the financial planning in addition to the real estate loan.

  • If the loan is paid off after a few years, the ground rent still continues.

  • Not every bank finances real estate that is built on a property with heritable building rights be erected. Home builders should find out in advance who is eligible for construction financing.