What’s the Story with Leasehold Extensions and Bali Real Estate?
What’s the Story with Leasehold Extensions?
Patrick Clancy of Bali Nirmana Property clearly explains how a typical leasehold agreement in Bali is structured, and how savvy investors are maximizing their returns on the wide range of leasehold properties on the market by knowing the strengths and weaknesses of their own lease agreements.
A typical leasehold acquisition on a villa in Bali will consist of several important components, chief among them are the length of the initial tenure, the length of the extension term, and the terms and conditions for actualizing that extension.
What about these 15 year leasehold villas I see marketed for sale?
Twenty five year lease terms have been the norm, but we have also seen terms of 30 and 35 years as well. Many land owning families are reluctant to sell their family land for a variety of reasons, so the use of the Hak Sewa (Right to Lease) has been a very popular vehicle to allow foreigners to acquire property and develop their version of the Bali dream villa. While many leasehold properties currently on the market are listed as having less than 25 years left on the initial tenure, they did at one time have the full term of 25 years or more at their inception.
What is the deal with the extension? Is it guaranteed?
I have had the pleasure in participating in many lease transfer transactions, be they from the original land-owner to a foreigner, or from a second party who had purchased the leasehold rights to the property but has decided to move on and transfer their lease rights onto the next party. Only twice since 2005 have I seen an example of a foreigner not being granted the extension that was an option in their original lease agreement. In one instance the lessee was ridiculously unreasonable in his request not only for a price well below market value, but he had a laundry list of upgrades that he wanted the land-owner to make to the villa that the lessee himself built. And in another. The family was at great odds with one another – a lot of infighting – and they could not bring the wayard son into the fold to agree with the rest of the family. I have seen hundreds of examples where they process to extend was quick, clear, in accordance with the guidelines of the agreement, and a great benefit to both parties.
Each and every lease agreement has got specific language regarding the terms and conditions for extending the lease, most often for a term equal to the initial tenure. While no two agreements are exactly alike, they each will have some common guidelines. It is important to note here that, with very few exceptions, the cost of the extension is based on the land value only, not upon the land value plus the cost of the villa, swimming pool and improvements.
First and foremost is the length of the extension. Typically, an agreement that was originally established as a 25 year lease will have an option to extend for an additional 25 years. We have seen 30 year leases with 30 year options, 20 year leases with 20 year options, and several variations of each. When a second party who took possession of a leasehold villa in 2008 with a 25 year term is looking to sell their leasehold villa in today’s market, they will offer it as a 15 year lease with the option to extend. Each of the terms and conditions agreed upon between the land owner and the second party are transferred to the third party upon successful due diligence and receipt of final payment. The third party now owns a 15 year lease with the option to extend for an additional 25 years, based on the terms and conditions spelled out in the original lease between the land owners and the second party.
They standard language around establishing the price of the lease extension will vary from lease to lease. Many leases simply state that the lease can be extended based on the market value of the land at the time of the extension. How this value is determined is the subject of much debate, but in the end, establishing the price of the extension comes down to the relationship between the land owner and the lessee. More on this later. Some of the better lease agreements have the mechanism for establishing the price included in the body of the lease agreement in an attempt to reduce the ambiguity around establishing market value. Either 3 or 5 agents will be appointed by both parties to submit their professional opinion of the land value and the average of those submissions is proposed as the extension price. And in rare cases, the actual value of the extension is pegged to the value of a number of grams of gold. In extremely rare cases, the price of the extension is clearly stated in the agreement, allowing the subsequent parties to have the certainty of knowing the cost to extend in advance. These leases are rare though and we would caution against waiting until you ‘find’ one in your search for your next property. A vast majority of the leases on the market today will use the more simplified language of ‘market price’.
While the timing and the conditions for extending the lease may be clearly stated in the lease agreements, we have found that many land owning families are willing to extend the lease before the stated term in the agreement. So while the language of the agreement might stipulate that the parties agree to meet to set the extension prices in motion when there are 12 months remaining on the initial term, oftentimes the land owning may be willing to top up in advance. This is where the all-important component of maintaining a good working relationship with the land owning family really comes into play. If you’ve not established a relationship with the family and the first time they meet you is to discuss extending the lease at a price that you feel is reasonable, you may find that they are not that willing to bend the terms of the agreement and top up immediately. They may politely defer to the family unit for conversation and then return with the news that the family prefers to wait before extending. But do not be too surprised if the outcome of your first meeting with the family asking them to extend the agreement outside of the already agreed upon terms does not go your way.
My own personal experience with the land owning families has shown me that that the laws of supply and demand clearly apply. When I have approached the family to top up my own lease the opening price that is offered by the family is above and beyond the market price at the time. This makes perfect sense to me, even though it is not what I want to hear. They have what I want – namely all of the time in the world. When the land owning family has approached me to extend my contract, the tables are turned and I offer a price that is below the market value, knowing that they will come back with a counter offer that is fair and reasonable to both parties. But one of the key components to my leases has always been to establish a relationship with the family as quickly as possible and make the first meeting with them is one in which I bring something to them, not one where our fist meeting is me asking them for something. Sending a suckling pig over to the family home at Galungan and Kuningan has proven to be a very effective gesture at keeping the relationship warm and fuzzy and it costs less than what you’ve likely got in your pocket right now.
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