Types of Leases Flashcards
Remember, an estate is a possessory interest in real property, so an estate and an interest are the same concept.
Freehold Interests: A Review
A freehold estate is a form of ownership with an indeterminate length.
Someone who owns the home they live in and the property they live on likely holds a freehold interest in that property. They own the property for the foreseeable future unless they choose to sell it.
Leasehold Interests
A leasehold interest, or leasehold estate, is an interest in the occupation of a property established through a lease. This can also be referred to as a non-freehold or less-than-freehold interest and it allows a tenant to occupy a property they don’t actually own. If an interest is established through a lease, that typically means that the occupancy has a determined length, whether that be six months, ten years, or four days.
Freehold vs. Leasehold
The main difference between a leasehold interest and a freehold interest is ownership. Freehold estates include ownership and leasehold estates do NOT include ownership.
Check out this image to help you compare:
A venn diagram showing the differences and similarities between freehold estates and leasehold estates.
Image description
Property Interests
A leasehold interest is created with the use of a lease.
A lease is a contract in which one party conveys property to another for a specific, predetermined period of time, generally in return for a periodic payment. A lease is a contract that creates a conceptual interest in property and defines what that interest looks like.
Leases are also commonly referred to as rental agreements. In Arizona, a lease doesn’t always have to be in writing, if less than 12 months but it’s recommended.
Lease Components
A lease is a legally binding agreement and should contain all of the following components:
Dates of occupancy
Description of the space (may include a unit number)
Names AND signatures of the lessee and the lessor
Terms of the lease
Policy for automatic rent adjustments
Landlord access rights
Payment specifics, such as:
Rent amount
Where and how to pay rent
Security deposit procedure
Rights, responsibilities, and obligations of both parties
Prohibition of illegal activities on the property
Eviction process
Lease Overview
A lease allows the tenant to occupy the landlord’s property for a specified period of time at a certain rental price until the lease expires.
At a basic level, a comprehensive lease must define:
The tenant and landlord’s rights and obligations
The time frame of the contract
The price to use the property
The lease agreement is an express contract between the parties giving the tenant the right to possession and the landlord rental income.
The landlord has a right to collect payment and also has a reversionary right, which is the right to regain ownership of a property.
Parties to a Lease
Leases are typically created between two parties:
Landlord: the party granting the lease, aka the lessor
Tenant: the party to whom the lease is granted, aka the lessee
Leases
It takes all kinds of leases to meet the needs of each landlord and tenant.
Types of leases can be divided into two main groups:
Leases that establish a type of estate.
Leases that depend on how rent is paid.
First Up: Residential Leases
In this chapter, we will go over leases that establish a certain type of estate. These are the different types of leases you will be most concerned with if you’re working in residential leasing. They are defined by the length of the lease term.
Residential leases usually last for a year or less. They tend to be pretty uniform in their features, without much negotiation over the lease terms. This makes things simpler for apartment complex managers and gives renters a good idea of what to expect.
Coming Soon: Commercial Leases
In the next chapter, we’ll go over leases that are defined by how rent is paid. These types of leases are mostly used in commercial leasing.
Leasehold Estates
A lease can establish one of the following types of estates:
Estate for years: stipulates a specific starting and ending time to the lease; also known as a tenancy for years or tenancy for a specific term
Periodic estate: has a fixed lease period, after which it is automatically renewed until either party to the lease acts to cancel it; also known as a periodic tenancy, estate from period to period, or estate from year to year
Estate at will: allows a tenant to occupy a property with the landlord’s consent; the tenant or the landlord can end the lease at any time
Estate at sufferance: occurs when a tenant remains in possession of the property beyond their lease’s terms without the consent of the landlord; also called a tenancy at sufferance
We’ll go over each of these in more detail.
Types of Leases
Though it’s called an estate for years, this kind of estate does not have to actually last for years. It could last for a matter of months or even days. (I’ve got estates for days, Anthony!) It’s simply important that the lease includes a specific starting and ending date.
Once the lease expires, neither the landlord nor the tenant needs to act to terminate it. It just ends, all on its own. If the landlord and tenant want to continue with their arrangement, they must come together and expressly agree to either renew the existing lease or create a new one at the end of the lease term. This means that an estate for years does NOT come with automatic renewal.
Estate for Years
With a periodic estate, the lease is automatically renewed at the end of each lease period until the landlord or tenant acts to terminate it. It does NOT have a specific ending date. These are often referred to as month-to-month leases.
If a lease’s terms are vague, courts will likely rule that the lease establishes a periodic estate. The Uniform Residential Landlord and Tenant Act (federal law that we’ll get to later) supports this. And in Arizona, the default type of periodic estate is a month-to-month lease.
This may or may not work out favorably for the parties involved. First-time renters can be surprised to find that their year-long lease (sounds like an estate for years, right?) automatically renews if they fail to give the landlord notice to vacate a month or two prior to the lease’s end date. It’s better to clarify things upfront.
Periodic Estate
With an estate at will, a tenant occupies a property with the landlord’s knowledge and consent, but without a formal lease agreement. This arrangement is nice because it is extremely flexible, but it’s also unpredictable.
Pros and Cons
For some tenants, the flexibility of an estate at will might be a good thing. Likewise, some owners might be happy to collect a little rental income without committing to renting out the property for a specific length of time.
For tenants and landlords who prefer stability (of shelter or income, respectively), the unpredictability of an estate that can be discontinued at any moment would be a drawback. Also, an estate at will won’t clarify who will address maintenance issues, like fixing the fridge if it breaks. 😕
Estate at Will
With this kind of estate, the landlord is passively allowing the tenant to stay in the property until eviction can occur. The tenant who stays beyond their lease’s terms is referred to as a holdover tenant.
In Arizona, if a holdover tenant willfully and in bad faith refuses to leave, the landlord can recover an amount equal to two months’ periodic rent or twice the actual damages, whichever is greater.
EXAMPLE
Emily rents a home with a lease that ends on August 30. She really likes the property, however, and decides to stay through October. Her landlord does not want her to stay because they already have new tenants lined up for September 1. When Emily stays past the designated termination date, she creates an estate at sufferance.
Let’s Review
Great job, Anthony! Let’s review the leasehold interests that establish a type of estate then play a quick game to test your knowledge.
A chart that lists the characteristics of each type of leasehold estate.
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Estate at Sufferance
Another type of residential lease is the proprietary lease. It’s a long-term and exclusive lease given to the resident and stock owner of a cooperative.
This is very similar to a standard lease between a tenant and a landlord. The difference is that, in this case:
The landlord is the cooperative.
The tenant is the shareholder (who is also residing in one of the cooperative’s units).
Proprietary Leases
Section 8 programs are designed to help people with low income afford housing. The type of lease is not particularly relevant here, but if you choose to work in residential leasing once you get your license, you will want to make sure you’re familiar with Section 8 programs.
The U.S. Department of Housing and Urban Development (HUD) provides the funds for individual states to run their Section 8 programs. Each state manages its programs at the local level with the help of public housing authorities.
Here, the Arizona Department of Housing manages two different Section 8 programs:
The Housing Choice Voucher Program: In this program, people who meet the eligibility requirements get assistance with their monthly rent costs.
Project-Based Rental Assistance: This program is administered by the Arizona Public Housing Authority (APHA). Across the state, there are about 800 project-based Section 8 properties. Each of the properties has a Housing Assistance Payments Contract with HUD, and APHA administers those contracts for HUD.
For both of the above programs, APHA processes applications to determine who is eligible based on financial need. While financial need is a primary factor, APHA may also give preference to the elderly, families, and people with disabilities.
Residential Leasing and Section 8
A lease can be as long or as short as the landlord and tenant want it to be, which brings us to our next type of rental agreement, short-term (aka vacation) rentals.
According to state law, a vacation rental or short-term rental is defined as:
any individually or collectively owned single-family or one-to-four-family house or dwelling unit or any unit or group of units in a condominium, cooperative or timeshare, that is also a transient public lodging establishment or owner-occupied residential home offered for transient use if the accommodations are not classified for property taxation
So, we’re talking about practically any type of property that is offered up to the public for short-term lodging. “Short-term” is not defined above, but we’re generally talking about a matter of days or weeks. This definition does NOT include property that is used for non-residential purposes (for example, event spaces, restaurants, and retail shops).
Arizona Laws
State law says that a city or town in Arizona can’t prohibit short-term rentals. They can’t limit the use of such properties or otherwise regulate them based on their classification as short-term rental properties.
However, a city or town can regulate short-term rentals if the rules are put in place for any of the following reasons:
To protect public health and safety: A city can insist that a vacation rental adhere to building codes, fire code, and other standard rules about waste, sanitation, and pollution. As long as the regulation has the primary purpose of protecting people’s health and safety, it’s valid. ✔️
To adopt and enforce residential use and zoning ordinances: Residential ordinances address things like property maintenance, noise levels, and other nuisances that could upset the neighbors. Such rules are fine as long as they’re applied evenly to all residential property, not just short-term rentals. ✔️
To limit or prohibit the use of short-term rentals for certain activities: Lastly, it may be within a community’s rights to prohibit the use of short-term rentals for certain activities. These can include selling illegal drugs or operating adult-oriented businesses. A city can also rule against short-term rentals being used for housing sex offenders or running a sober living home. ✔️
Short-Term and Vacation Rentals
To close out our discussion on types of leases, we’ll talk about how a lease can act as a financing tool by establishing a rent-to-own arrangement.
All of the leases we have talked about so far have one thing in common: they end. A lessee’s interest in a property will always terminate one way or another. Ideally, the renter takes one last, wistful look at their emptied apartment on moving day, gives a solemn nod of approval, and leaves to turn in their keys.
But a lease with an option to buy is a little different. A lease with an option to buy, or lease-option agreement, is a contract in which the buyer can lease a property for a period of time (usually a year or two) and then have the option to buy the property. The lease contract will spell out when the property can be purchased and at what price.
The sales price can be “locked in” at the time the parties enter the contract, or it can be based on the market value at the time of the sale. But whatever the sales price, it should be specified in the lease.
Option is a term that gives one party the right to perform a non-obligatory action within a time period. In the case of a lease-option agreement, the buyer has the option to buy the property they have been renting, as long as they choose to buy within a certain time frame.
Equity
With other types of leasehold interests, a lessee’s rental payments do NOT earn them any return (as opposed to what happens to a homeowner paying a mortgage who builds equity with each monthly payment).
But with a lease-option agreement, the lease option can specify how much of the rent payments can be applied to the future purchase of the property. It’s kind of like building potential equity, which is a benefit for lessees (or buyers).
Unilateral
An option-to-buy is unilateral, meaning only one of the parties is required to act. Since it’s an option, the tenant does not have to buy the property if they don’t want to. (But the seller is required to sell if the buyer chooses to buy.) The buyer can walk away from the deal, but may forfeit any up-front option fee they paid to the seller at the start of the agreement.
If the tenant does not exercise their option to buy, the landlord also gets to keep any other payments that would have been applied toward the down payment.
The Option Fee
Where an estate for years may require a security deposit, a lease-option will include an option fee.
The optionee (prospective buyer or tenant) pays the optionor (landlord or seller) a nonrefundable deposit upfront. This deposit is an option fee that is usually applied to the purchase price of the property. The option fee gives the optionee the choice of purchasing the property before the conclusion of their lease. The option fee fulfills the requirement for consideration, which is an element of a valid contract.
Rent Credit
Once the optionee has paid the option fee, they must then pay the optionor a monthly rent to compensate them for their use of the property. A fraction of that monthly payment is usually applied towards the purchase price or down payment of the property (perk!). The optionee has the option of purchasing the property (according to the fixed terms in the contract) during the term of the lease.
However, once the lease expires, the option to purchase ceases to exist.
Lease with an Option to Buy
Like most things, lease-options have drawbacks.
Seller Problems
One issue is determining who will maintain the property during the “lease” period of the lease-option agreement. With a typical lease, the landlord maintains the property because they own it and are motivated to keep it in good condition. But with a lease-option agreement, the seller doesn’t have that motivation because they are trying to divest themselves of the property and, therefore, might not want to put any more money into it.
The seller might also grow concerned if the tenant isn’t caring for the property. The tenant may be creating repair issues that they can simply walk away from at the end of the lease if they choose not to buy. The lease should specify who will address maintenance issues and how damages will be handled.
Another common concern for the seller in these situations is that the typical lease-option tenant is not in a financially sound position. If they were more financially sound, they would just go ahead and buy. Therefore, the seller is knowingly entering into an agreement with someone who might never qualify for financing, which would put the future sale at risk. This prospect is doubly bad if the market is deteriorating.
An illustration of three houses with black roofs and one house with a red roof.
Buyer Problems
On the buyer’s side, there are a couple of issues to consider.
For under-qualified buyers, the cost of an opportunity to purchase property shows up in the price they end up paying. Option fees can be steep. Rental rates may be higher to account for the portion of rent contributing to the down payment. Also, if the buyer can’t qualify for the future payments they also lose all option payments. It’s a considerable amount of investment on the buyer’s part for a deal they may not ever be able to close.
Also, the property itself may not be all that desirable if it couldn’t attract a regular sale. A buyer could attempt to exercise their purchase option only to find that the seller can’t issue a good title, or the property doesn’t appraise for the agreed-upon price.
Lease-Option Issues
A lease-purchase agreement only differs from a lease-option agreement in that the tenant is required to purchase the property at a certain point. Buyers are generally advised to avoid this type of agreement and opt for a lease-option agreement instead.
Lease-option agreements allow for more flexibility in the case of a defective title or insufficient financing.
Is a Lease-Option a Good Option?
Both types of rent-to-own contracts appeal to people who cannot qualify for financing to buy a home outright. They may choose this option in hopes of “locking in” their desired home and taking a couple of years to improve their credit before buying it.
It can be a good course of action for some, but the flexibility of the lease-option is safer for buyers and still advantageous to sellers.
Get an Attorney
These types of transactions require the services of a real estate attorney to complete. Should you become involved in a potential lease-purchase or lease-option transaction, your best bet is to send the clients to a real estate attorney to work out the details and complete the documents.
Lease with an Obligation to Buy
I hope that this variety of leases illustrated to you just how many different opportunities there are out there for real estate professionals in the leasing market! You did a great job learning about these rental agreements, Anthony.
Before you go, let’s review some of the important terms, concepts, and principles you’ve learned along the way.
Key Terms
Here are the key terms you learned in this chapter:
estate at sufferance
a tenant’s occupancy of a property beyond their lease’s terms and without the landlord’s consent
estate at will
a tenant’s occupancy of a property with the landlord’s consent
estate for years
a lease with a specific starting and ending date; aka tenancy for years
lease
a contract in which one party conveys property to another for a specific predetermined period of time, generally in return for periodic payment
leasehold interest
an interest in the occupation of a property established through a lease
lessee
the party to whom the lease is granted; aka tenant
lessor
the party granting the lease; aka landlord
periodic estate
a leasehold estate which automatically renews until canceled by either party; aka estate from period-to-period, periodic tenancy, estate from year to year
proprietary lease
long-term and exclusive lease given to resident and stock owner of a cooperative
Key Concepts & Principles
Here are the concepts and principles you’ll want to master from this chapter.
Freehold vs. Leasehold
The main difference between a leasehold interest and a freehold interest is ownership. Freehold estates include ownership and leasehold estates do NOT include ownership.
A Venn diagram showing the differences and similarities between freehold estates and leasehold estates.
Image description
Leases
A lease is a contract in which one party conveys property to another for a specific, predetermined period of time, generally in return for a periodic payment. A lease is a contract that creates a conceptual interest in property and defines what that interest looks like. In Arizona, a lease doesn’t always have to be in writing, but it’s recommended.
A lease allows the tenant to occupy the landlord’s property for a specified period of time at a certain rental price until the lease expires.
At a basic level, a comprehensive lease must define:
The tenant and landlord’s rights and obligations
The time frame of the contract
The price to use the property
The lease agreement is an express contract between the parties giving the tenant the right to possession and the landlord rental income. The landlord has a right to collect payment and also has a reversionary right, which is the right to regain ownership of a property.
Short-Term and Vacation Rentals
A short-term (aka vacation) rental is a property that is offered up to the public for short-term lodging. State law says that a city or town in Arizona can’t prohibit short-term rentals. They can’t limit the use of such properties or otherwise regulate them based on their classification.
However, a city or town can regulate short-term rentals if the rules are put in place for any of the following reasons:
To protect public health and safety
To adopt and enforce residential use and zoning ordinances
To limit or prohibit the use of short-term rentals for certain activities
Lease-Option Agreements
A lease with an option to buy, or lease-option agreement, is a contract in which the buyer can lease a property for a period of time (usually a year or two) and then have the option to buy the property. The lease contract will spell out when the property can be purchased and at what price.
An option-to-buy is unilateral, meaning only one of the parties is required to act. Since it’s an option, the tenant does not have to buy the property if they don’t want to. (But the seller is required to sell if the buyer chooses to buy.)
In a lease-purchase agreement, the tenant is required to purchase the property. Both types of transactions call for the services of a real estate attorney.
Chapter Summary
Commercial Leases
