Legal interests in real estate seem simple upon first consideration – someone may own a home, and when they sell it, the buyer owns it. However, even such “simple” purchase and sale arrangements are often layered with other forms of legal interests being retained or changing hands, such as mortgage lien rights, easements, tenant rights and restrictive covenants. Holding an interest in property does not mean just one thing and even the descriptor of “ownership” fails to identify important differences among ownership types. Financial, tax and estate planning goals often are best accomplished by using forms of property transfers outside of traditional sale and purchase agreements and understanding such mechanisms is important to making efficient decisions about your real estate.
It is helpful to first present a framework for which to analyze the differences between types of interests. The classic real estate analogy to help frame the various rights and obligations of land ownership is the “bundle of sticks” thought exercise. First, imagine a bundle of sticks, where each stick represents a right or obligation regarding a particular piece of real property. One stick, for example, is the right to occupy the property, another may be the right to build or destroy structures on the property. When someone has all of the sticks, representing every conceivable right to the land, they are the “owner” in the truest sense of the word for the land associated with the sticks. However, individual sticks are often removed from the bundle and given to others – thus the rights to the property are divided among different people and entities. In fact, no individual holds all the sticks to any given bundle because certain property rights are held by the government. Some examples of this are: the right to tax, to prevent certain uses of the property through zoning and permitting requirements, and to forcibly acquire property through eminent domain. The remainder of the rights are typically divided in one of the following classifications of interest in real estate:
Fee Simple Interest. An owner in “Fee Simple” holds the most rights to real estate any individual can enjoy. They can occupy and use the property as they see fit, exclude anyone they do not want to be there, sell or rent to whomever they like, and build or tear down any structures so long as they comply with the governmental limits to such powers. Their use of the property exists currently and there is no time limit on such use.
Leasehold Interest. The first interest in real estate most people acquire is the leasehold to their first apartment. This interest is also referred to as a “Lessee” or “Tenant” interest. Lease rights vary tremendously based on the terms of the lease contract, but in general, ownership is retained by the landlord and the right to occupancy, use, and enjoyment for a set length of time is sold to the tenant for the price of rent. While the ownership of the property is retained by the Landlord, those occupancy rights are temporarily transferred away from them. This transfer of rights is what separates a “tenant” from a “guest.” For example, despite being the “owner” of the property, Landlords generally do not have the right to sleep or live in the rented space, invite guests over or tell their tenants who is and is not allowed on the premises – these rights are retained by the Tenant for the duration of the lease.
Landlord Interest. The opposite of the leasehold interest, the Landlord, also known as the “Lessor,” retains the rights not traded for rental payments to the Tenant. This typically includes the rights to make decisions regarding the improvements on the property (although some leases allow Tenants wide discretion to remodel or even build improvements), the right to sell the property to others, or encumber it with a mortgage to finance other projects, and to have the property returned to them at the end of the lease.
Life Estate Interest. Life estate arrangements transfer the “sticks” associated with a property after the owner’s death to another party, often as a gift but sometimes as a sale, but keep the “sticks” for use during one’s life with the owner. The rights to use the property during life is called the “Life Estate Interest.” This typically involves the holder being able to live in the property rent free for the duration of their life. In theory, the “Life Estate interest” can be sold to a third party, but because it terminates on the death of the original holder (it does not reset to the lifespan of the buyer), few people are interested in purchasing such rights. Life Estate interest holders are usually required to pay the property taxes and keep the improvements in good repair to protect the value of the remainder interest holder’s rights. Granting a Life Estate is fundamentally different than naming someone in a will, as the legal ownership of the right to use the property after the grantor’s death irrevocably transfers to that individual and cannot be rescinded.
Remainder Interest. The opposite of the Life Estate Interest, the holder of the remainder interest has no current use or occupancy rights but will assume full ownership of the property when the Life Estate interest holder dies. They also have certain rights to ensure the Life Estate Interest holder keeps the taxes paid and the property in good condition, as failure to maintain the property damages their future rights. A remainder interest holder can sell their remainder interest to other parties. The value of such interests is typically determined by the life expectancy of the Life Estate interest holder.
Mortgage Liens. Banks and other financial institutions own interests in a huge number of properties in the form of mortgage liens. Individual lenders may also acquire such rights. When a bank lends you money to purchase a home, or sometimes for other reasons, they may “secure” that debt by placing a mortgage lien on the property. This grants a “conditional right,” meaning that if certain events happen, the right comes into effect. The main conditional right with a mortgage lien is the right to seize the property from the borrower if payments are not made or if the borrower attempts to transfer the property without their consent, which is frequently called the “due on sale clause.” Lenders require these liens be granted to them to ensure that they will receive their money back from the sale of the seized home in the event the borrower stops paying the loan.
Land Contract Vendor. The Vendor of a land contract makes a contract with a purchaser or “Vendee” to sell specific land in exchange for a promissory note which is paid over time. In a traditional mortgage financed transaction, the seller is fully paid at closing from the money the borrower got from the bank and transfers the full interest at that time. In a land contract however, the payments are made directly to the Vendor over a number of years, and the title is retained until it is paid in full, at which point the Vendor is required under the contract to transfer the property by deed to the Vendee. Although title remains with the Vendor until the note is paid, for most practical purposes, the use and occupancy rights to the property transfer to the Vendee upon signing the Land Contract, at least for so long as the Vendee stays current on their payments.
Land Contract Vendee. The Vendee of a land contract agrees to purchase the property from the seller, or “Vendor.” The Vendee has a right to acquire the property when they have completed the payment schedule called for in the Land Contract. They typically have broad rights to use the property while paying off the debt, but also are typically required to maintain insurance and maintenance to protect the security of the Vendor. If they fail to make the payments, the Vendor may be able to seize the property back from them, as the legal title to the ownership never changed hands.
Easements. The owner of an easement right does not own the property it pertains to, but rather has specific rights to use that property for specific purposes. The most common form of easement is for access, also known as “ingress and egress easements.” If a lot is created that has no access to a public road because it is surrounded by other lots, it is common for the owner of that lot to negotiate for the purchase of an easement on someone else’s property for the right to travel across it to get to the road. Other common easements are for hunting or recreational use. Easements are presumed to be “appurtenant” to the land, meaning future owners automatically get the rights and obligations transferred to them when they buy the property. However, some easements are “in gross” meaning an individual owns the easement right (common with hunting easements). If an easement is vital to the use of a property, buyers should carefully ensure the rights will continue after the property changes hands.
Restrictive Covenants/Deed Restrictions. Where an easement is a right of another to use someone else’s property for a specific purpose, a restrictive covenant or deed restriction is the right of another to prohibit certain uses of a property by its owner. For example, the owner of a house on a hill may decide to sell some of their land at the bottom of the hill. Because they are worried about their view being blocked if the new owner builds a tall structure, they retain for themselves the “stick in the bundle” that represents the right to build structures over a certain height. The new owners take title to the land, but never obtain the right to build any structure that would block the view. The most common type of restrictive covenants are found in property developments, where the developer, to increase the value of the land or houses they are selling, puts use restrictions on all of the lots. While the value of a single property may be decreased if it comes with rules about what the owner cannot do with it i.e., “no barking dogs on the property” and “no non-running cars in the driveway,” the value may increase significantly if all the neighboring properties also are prohibited from owning barking dogs or leaving junk cars out front as buyers get the peace of mind in knowing their neighbors cannot do these things.
Option to Purchase. An option to purchase grants the legal right, but not the obligation, to acquire a property at a set price during a window of time. If exercised by the option holder, the owner is legally required to sell them the property. The owner may still occupy and enjoy the property during the interim and the option holder has no rights to the property unless they exercise the option. Options become more valuable if the land value increases, as the right to buy a property for $100,000 that has doubled in value since the option was granted obviously is quite valuable. Option rights are typically sold to purchasers when they express interest in a property they cannot currently acquire and want to secure their right to buy it in the future.
Right of First Refusal. A right of first refusal is a contractual right to have a property offered to be sold to the holder for a set price and terms before the owner can sell to anyone else. The right holder does not own the property or have any ability to force the sale, but if the seller wishes to sell, the right holder will be guaranteed a chance to buy the property themselves. The price is sometimes set to match the offer made by another party, requiring the right holder to match the outside offer to acquire the interest. Sometimes the terms call for a formula or appraisal-based price determination instead. Rights of First Refusal are often utilized in family land transactions when the real estate is sentimental in some way. For example, if two siblings inherit their family home, one sibling may wish to purchase it from the other to live in. That sibling may agree to the sale but only on the condition that before they could sell it to someone else, they would have to first offer it back to them.
If you have any questions about these types of interest in real estate, please do not hesitate to reach out to one of our experiences real estate attorneys.