As we have already seen, in most leases, the rent is not fixed, or predetermined, for
the full term of the lease. Rather, at certain dates (called renegotiation dates), the
lessor and lessee must agree on a new lease rent. Lease rent renegotiations are usually
scheduled in 10 to 15 years intervals after the initial fixed rent period (usually 25 to
30 years). The majority of leasehold apartment units in the State of Hawaii are due to
renegotiate lease rents between the years 1990 and 2019.
Most leases contain a formula for determining the new lease rent. Because the formula
is frequently based on rent and market conditions existing on the renegotiation dates, the
rent could rise dramatically and is not known with certainty until the actual time of
renegotiation. As a buyer, it is important to read the lease documents carefully so that
you understand when and how the new lease rent payments will be calculated upon
renegotiation.
Most general leases provide a formula for the renegotiated rents to be based on a
stated rate of return on the market value of the land under the project at the time of
rent renegotiation. For example, if at the time of renegotiation, the value of the land
under a 100-unit condominium is $5,000,000 and the stated rate of return is 7%, then the
formula would result in a renegotiated rent of $3,500 per year or $291 per month
($5,000,000 X 7% X 1%, assuming your unit represented a 1% common interest in the land).
In other cases, the rate of return is an amount to be renegotiated based on current
land value and current rates of return. Two other less common methods for determining
renegotiation rent are 1) Basing the new rent on current market rent for similar
buildings; and 2) Increasing the current rent by the change in the consumer price index
over the preceding fixed rent period.
Under all but the last method, leases generally provide that if the lessee and lessor
cannot agree on the new lease rent before the beginning of the renegotiated rent period,
the rent will be determined by an arbitration procedure. For example, the lease may
specify that the market value of the land will be decided by three impartial real estate
appraisers, one to be chosen by the lessee, one by the lessor, and the third selected by
the first two. In deciding the market value, the land is usually treated as though it had
no structures on it.
After the market value of the land is determined, it is multiplied by a percentage rate
of return specified in the lease (or, if not, then determined by the appraisers) to
compute the rent for the entire apartment unit project. Then this figure is multiplied by
the lessee's percentage share in the common interest in the project to determine the
amount of the lessee's individual rent.
Many leases have the rate of return set at a specific rate. Other leases may provide
that the rate be based on the prevailing rate of return for similar properties at the time
of renegotiation. The prevailing rate of return for similar properties will depend on
market conditions existing at the time of renegotiation.
As you can see, this method of calculating renegotiated lease rent is tied closely to
current land value. Since their is no upper limit on land value other than current market
conditions, the new rent may increase greatly. This increase will reflect the rise in land
values since the beginning of the lease 25 to 35 years ago.
What is mandatory arbitration?
Hawaii law provides that all ground leases for condominium and cooperative projects
must contain a provision for the mandatory arbitration of any renegotiated rent. This
means that if the lessee and the lessor cannot agree on a new rent before the
renegotiation date, either may request that the rent be decided by an impartial party. For
example, this impartial party would include a panel of real estate appraisers.
If the lease does not provide for the arbitration of lease rent and if the parties are
unable to agree on the rent upon renegotiation, than the law specifies the process to
follow. The law does not, however, specify or limit the amount or rate of rent to be paid.
Here is the required procedure:
- The new rent shall be determined by three impartial arbitrators who are recognized real
estate appraisers.
- The lessee and lessor will each select one appraiser. The first two appraisers will
select the third.
- The three appraisers will determine the renegotiated rent and their decision will be
final and binding.
- The lessee and lessor will share the costs equally.
What are the lease rent renegotiation formulas for cooperatives?
Hawaii law provides a ceiling for renegotiated rent for cooperative apartment projects
that qualify under the law. This law does not apply to rent renegotiation of units in
condominium and PUD projects.
The law applies to all cooperative proprietary leases which call for rent
renegotiation. It provides that renegotiation of rent cannot take place more than once
every 10 years and the first renegotiation can be no sooner than 15 years following the
commencement date of the lease. It also provides a formula for determining the maximum
amount of renegotiated lease rent to be paid by the cooperative housing corporation.
If the lessee corporation and the lessor cannot come to an agreement on the new lease
rent, the law requires that the rent be determined by an impartial Third Party through
arbitration proceedings conducted by the State Housing Finance and Development Corp.
