Putting Idle Land to Use: Condos with Fixed-Term Leases Have Advantages in Accounting

Condominiums with fixed-term leasehold rights (“condos with fixed-term leases”) are gathering attention as a new way for companies to put their idle land to use. Generally, companies utilize idle land that they own by building properties there and leasing them to earn income from rent—these properties may be leased condos, offices, or commercial facilities, for example.

May 16, 2019

Unfavorable land can be put to effective use

In the case of a condo with fixed-term leases, the owner of the land doesn’t invest in the building, but rather, earns rent on the land by leasing the land to a condominium developer. Although the market prospects on the land rent vary, generally speaking, it should be about two to three times more than the fixed asset tax charged on the property. When you take a condo’s profitability alone, this doesn’t appeal to land owners in terms of business as much as developing a lease property themselves.

Then, why do condos with fixed-term leases—whose profitability is even less appealing—attract attention? There are several reasons, but the biggest of them could be because they can turn land that was previously difficult to make use of into a profitable property. Masatoshi Aikawa, manager of the JLL Japan Strategic Consulting & Valuation Department, which provides consulting services to companies regarding ways to make use of land that they own, notes, “Favorable locations where you can invest in buildings and expect a sufficient return will be fine, but if the land is in the suburbs away from any major train stations and rather large, and you build a new lease property there, it will take longer to collect what you invested, or the yield will be low, and you won’t get the returns that you expected. However, with a condo with fixed-term leases, you can sometimes find business potential, even in difficult land like that.” Large pieces of land in the suburbs are also good locations to build a logistics center or commercial facility, but logistics center development projects are often blocked by the limitations on land use that were decided in urban planning. Again, commercial facilities need to be built in favorable locations along major roads so that they can attract customers. Idle land that meets these conditions are few and far between.

Land owners enjoy advantages in accounting

Let’s take a look at the details of a project to build a condo with a fixed lease to make use of idle land that was undertaken by the JLL Japan Strategic Consulting & Valuation Department. The client was a general company and owned the land. Instead of building on the land, the client decided to sign a 70-year fixed-term land lease with a condominium developer. The condo developer built a condominium, and sold units to end users. After 70 years when the lease expires, the land will be returned to the company—the owner of the land—as raw land after taking down the building.

The fixed-term leasehold rights system was created in 1992, but condos with fixed-term leases had relatively short lease periods back then, expiring in 50 years. The project that JLL undertook, described above, extended the lease period to 70 years in order to eliminate the risk of residents leaving, and made the condo units more marketable by setting lower prices for the leasehold than for ownership of the property.

Meanwhile, the land owner enjoys advantages in accounting, as well. Although, Aikawa says, “It depends on conditions.” He clarifies as follows.

“Through negotiation, the owner of the land may be able to receive some percentage of the land rent for the 70 years of the lease period as an ‘advance deposit.’ The condo developer will decide on a sales price after taking into account the costs of the deposit. The land owner will get a sum of cash that is almost equivalent to the amount they can get by selling the land. In addition, there is no risk of the property turning into a non-performing loan, since no investment is involved. The net present value (NPV), an indicator used to judge investments by substituting the future cash flow of the investment target to its current asset value, will be higher than when the land is sold. Finally, the deposited rent is handled as an ‘unearned revenue,’ and rents that are divided by the number of years in the lease period are recorded on the accounting sheet—in terms of taxes, it is much more advantageous than selling land.”

Not for everyone, but will save the day for some

There are surprisingly many Japanese companies that are intent on never selling their land, and it appears that building condos with fixed-term leases has come into the spotlight as a result of purely exploring ways to make use of the land. However, developing and leasing a condo on fixed term involves a long leasing period, and lacks liquidity during that period. Land can be sold, but its ownership will be treated as a limited proprietary right, and the sales price will be significantly pushed down. Not only that, but operators who can afford the long lease period and amount of advanced deposit of land rent are limited to a few major developers that are financially strong.

“There isn’t a lot of idle land that would best be used by building a condo with fixed-term leases, and it’s not likely that there will be an explosive increase in companies that choose to build one as part of their CRE strategy. But for companies with idle land that they have no idea how to use, it may just save the day,” says Aikawa. This may not be for everyone, but it is worth considering as a CRE strategy.