Report Title:

Real Property Leases; Renegotiation

Description:

Requires, in leasehold renegotiations, that a rent based on fair market value shall apply even if the value is lower than existing rent and the lease contract bars the lowering of rent upon renegotiation. Allows a one-time rent adjustment to reflect fair market value for any existing lease renegotiated after January 1, 1990.

THE SENATE

S.B. NO.

903

TWENTY-SECOND LEGISLATURE, 2003

 

STATE OF HAWAII

 


 

A BILL FOR AN ACT

 

relating to real PROperty lease contracts.

 

BE IT ENACTED BY THE LEGISLATURE OF THE STATE OF HAWAII:

SECTION 1. The legislature finds that leasehold ownership in Hawaii has been, is, and will probably continue to be a common form of land ownership. Historically, the land ownership system in the state has been characterized by the concentration of the fee title to land in the hands of a few estates, trusts, and other private landowners. Such a pattern of land ownership on Oahu has led to the practice of landowners' leasing, rather than selling, their land.

From 1985 through the early 1990s, significant appreciation in the apparent and artificial values of real estate on Oahu occurred. Land prices were driven up in the 1980s by wealthy international buyers, many of whom were subsequently forced to sell their properties at huge losses because of economic troubles. Nevertheless, artificially high property values have been used by lessors as a basis to calculate long-term lease ground rents. Many lessees with long-term commitments have had to pay inflated ground rents and have suffered reduced or even negative cash flows. Others, who have not been able to pay the increased ground rents or pass them on to sublessees, have had to move. Those lessees who were personally responsible for their lease or mortgage obligations, or both, have faced foreclosures and bankruptcy.

Practices and policies that result in the use of artificially inflated land values have serious economic consequences, as evidenced by the plight of many commercial and residential lessees in Hawaii who face tremendous increases in renegotiated lease rents that are based upon land valuations that are too high. The resulting uncertainty creates a paralyzing effect on transactions concerning these properties.

In a 1991 report entitled "A Summary of the Research Findings from the Office of the Lieutenant Governor," it is noted that regarding condominium and cooperative units, "the majority of units are in leasehold projects."

In 1994, the business leasehold task force created by H.C.R. No. 312, H.D. 2, S.D. 1, chaired by Representative Calvin Say and composed of lessees, lessors, and concerned citizens, found that the rising cost of lease payments adversely affects the viability of Hawaii's businesses.

The task force reports: "Commercial lease rents have increased in recent years. Contracts negotiated some twenty or thirty years ago are coming up for renegotiation and some of the lessees have found themselves facing increases in excess of 200 per cent. Some are mom and pop operations and neighborhood shops. Increasingly, however, larger businesses, retail chains and other local commercial operations have been forced to shut their doors as their business becomes nonviable. Sadly, many jobs are lost, the goods and services they provided in our neighborhoods and communities are lost, their businesses and entrepreneurs are lost."

The task force also found fault with the practice of using arbitration to settle disputes over land values and recommended that changes be made.

In 1995, the United States Department of Housing and Urban Development financed a study by the Hawaii real estate research and education center of the University of Hawaii. The report resulting from the study states: "A mounting leasehold crisis exists in Hawaii's leasehold system and is the motivation for this study." The study also cites international monetary policies that resulted in a stronger Japanese yen and major investment in Hawaii real estate, which caused residential land prices to increase 367.8 per cent by the early 1990s.

The period from 1985 to 1990 has been called the "Japanese bubble period" or the "Japanese bubble economy years." The Japanese Ministry of Finance has defined the bubble as "a term referring to a deviation between actual and theoretical asset prices, but of such magnitude that it has an impact on the livelihoods of many people and interferes with a nation's normal economic management."

After the Japanese bubble period created problems, Anthony Downs, Ph.D., a senior fellow at the Brookings Institute, observed: "There are two basic causes of these unexpectedly high values. One is just the shortage of available and desirable land in Hawaii--especially of fee simple land--in comparison with the demand for it. This results in part from the general prosperity of the Hawaiian economy, plus the widespread ownership of land by a few big estates that have leased it to lessees who subsequently built improvements on it.

"The second cause is the extraordinary influx of the Japanese investment funds in the period from 1985-1989 that drove land prices to levels unsustainable from economic uses built on the land. Several circumstances affecting Japanese investors were unprecedented and unique. As a result, Japanese investors could and did pay huge prices for land that cannot be supported by any conceivable uses put on that land."

Appraisers in Hawaii have used land sales as comparable values in lease renegotiations and arbitration proceedings. The result is a setting of land values so high that the rents based on those values surpass the rate of return of the improvements on the land. Not only can the land values not be supported by existing improvements but they also cannot be supported by any new improvements, including the theoretically highest and best uses.

In Hawaii, when dealing specifically with real estate values and rental rates, the process of arbitration has contributed to creating the problems surrounding leasehold property. To remedy the problems, arbitration should be replaced by appraisal in determining leasehold valuations and rents.

Establishing fair rents based upon fair value was the purpose of Act 180, Session Laws of Hawaii 1998. However, the legislature finds that a need for additional clarification exists, since not all of the entities covered by Act 180 are currently complying with the requirements of the law.

The legislature finds that it is a critical and compelling public purpose to improve the state economy, to develop better job opportunities for the people of Hawaii, and to reverse trends that create windfall profits for lessors and corresponding losses to lessees. The leasing of property at fair value based on the use to which the property is actually put is essential to a healthy market.

To achieve such a goal requires the enactment of solutions that will eliminate the unreasonable and unlawful practices involved in past lease renegotiations.

In 1969, the legislature passed what is now section 519-1, Hawaii Revised Statutes. Section 519-1 provides that lease rent renegotiations under all leases should be based on the use to which the property was put under the terms of the lease. Lease rents are to be calculated according to the uses to which properties are put under the terms of the lease and not based on "some higher priced use" not contemplated by the contract.

Nevertheless, appraisers and arbitrators have not been able to follow or apply properly either the common law or section 519-1, Hawaii Revised Statutes, which has caused lease rents to be set so high that they burden many businesses in the state. Furthermore, because rents set by arbitrators cannot be appealed, lessees have had no recourse to enforce their legal rights. Since most businesses in Hawaii occupy leasehold premises, the impact of excessive lease rents has been harmful to them in particular and to the economy in general.

In addition, ordinance 91-95, Revised Ordinances of Honolulu, which provided a mechanism for converting leasehold interests in condominium and cooperative units to fee interests through the city's condemnation power, was subsequently upheld by the United States Court of Appeals for the Ninth Circuit in Richardson v. City and County of Honolulu, 124 F.3d 1150 (9th Cir. 1997), cert. denied, 119 S. Ct. 168 (1998). Specifically, the court observed that in enacting the ordinance, the city found that landowners had largely refused to sell proportionate shares in their fee simple titles; that the few sales that did occur involved exorbitant prices; and that such refusal to sell fee simple interests, combined with other factors, had caused a drastic rise in the price of housing in Honolulu.

The court further noted the city's finding that persons who desired to reside on Oahu were forced to sign long-term leases that provide for periodic rent renegotiation. The conditions led to the "acute recent inflation of land costs [that] has adversely affected lease rent negotiations of persons who have purchased leasehold multi-family units as their homes: in some instances renegotiations have resulted in lease rents that have increased over 1,000 percent. Under the burden of increased lease rents, many owner-occupants of residential condominium apartments . . . especially those on fixed incomes . . . have found, and will continue to find themselves unable to afford to continue living in their homes." Finally, the court pointed out the city's findings that such defects in the housing market would adversely affect Honolulu's economy.

The legislature finds that there is a need to reduce the potential for economic instability not only on Oahu but throughout the entire state. To accomplish the important purpose of using and managing land wisely for the public good requires changing the present practices involved in leasing real estate.

The legislature finds that a one-time adjustment to the current fair market value for ground leases affected by the Japanese bubble economy will alleviate the negative impact of the unexpected phenomenon while strengthening the economy of the state and promoting the welfare and security of its residents.

Such an adjustment to existing ground leases would not be a substantial impairment on contractual obligations since the rent to be determined under the one-time adjustment would not be lower than the rental amount determined in the period prior to 1985. Moreover, after the adjustment, the terms of the lease would continue to govern future rent negotiations. The one-time adjustment would allow lessees to pay current market rent (after years of paying above-market rent) and remain economically competitive with businesses in other parts of the nation and the world. Such action would help promote a secure, strong, and stable economy in Hawaii. Therefore, making the leasing of real estate viable for lessees is a valid public purpose. This type of legislation has also been upheld by the United States Supreme Court.

In Home Building & Loan Association v. Blaisdell, 290 U.S. 398 (1934), the U.S. Supreme Court validated--against a challenge based on a contractual clause--a mortgage moratorium law that Minnesota had enacted to provide relief for homeowners threatened with foreclosure during the Great Depression.

Residential lessees who own cooperative apartments are situated similarly to commercial lessees. Although chapter 38 of the Revised Ordinances of Honolulu has given cooperative-apartment owners the right to seek mandatory conversion, no cooperative-housing corporation has been able to proceed under the law because none has been able to meet the eligibility requirements of the ordinance. Thus, cooperative-apartment lessees have been unable to obtain their leased-fee interest.

The purpose of this Act is to rectify the effect of the Japanese bubble economy on long-term ground leases and to require that future leasehold rent renegotiations base the rental amount on fair market value as determined by appraisal under the Uniform Standards of Professional Appraisal Practice. Any difference in appraised value shall be resolved by an appraisal process that conforms with the uniform standards and not by arbitration as described in chapter 658A, Hawaii Revised Statutes. Any appraisal or rent determination that does not follow the uniform standards shall be subject to being set aside by a court of proper jurisdiction if a civil action is initiated.

SECTION 2. The Hawaii Revised Statutes is amended by adding a new chapter to be appropriately designated and to read as follows:

"Chapter

REAL PROPERTY LEASE CONTRACTS

-1 Definitions. As used in this chapter, unless the context clearly requires otherwise:

"Fee owner" means the person who owns the fee simple title to the real property leased under a property development and the person's heirs, successors, legal representatives, and assigns.

"Lease" means the same as in section 519-1.

"Leased fee" and "leased fee interest" mean reversionary interests of the fee owner, lessor, and all legal and equitable owners of land that are leased, other than the lessee's or a sublessee's interest.

"Legal and equitable owners" means the fee simple owners and all persons having legal or equitable ownership interests in the leased fee or in the lessor's leasehold estate, including mortgagees, developers, lienors, and sublessors, and their respective heirs, successors, legal representatives, and assigns.

"Lessee" means any person who leases or subleases land from another, and the person's heirs, successors, legal representatives, and assigns.

"Lessor" means any person who leases or subleases land to another, and the person's heirs, successors, legal representatives, and assigns.

"Lessors," "lessees," "fee owners," and "legal and equitable owners" include individuals, both male and female; corporations, firms, associations, partnerships, limited liability companies, trusts, and estates; and the State of Hawaii and any county or other political subdivision of the State. When more persons than one are the lessors, lessees, fee owners, or legal and equitable owners of a lot, the terms apply to each of them, jointly and severally.

"Uniform standards" means the current Uniform Standards of Professional Appraisal Practice approved by the director of commerce and consumer affairs pursuant to section 466K-4(a).

-2 Lease renegotiations; calculation of rent; definition. Whenever any agreement or document for the lease of private lands provides for the renegotiation of the rental amount or other recompense during the term of the lease, and the renegotiated rental amount or other recompense is based, according to the terms of the lease, in whole or in part upon the fair market value of the land, or the value of the land as determined by its highest and best use, or words of similar import, such value, for the purposes of determining the amount of rental or other recompense, shall be calculated upon the use to which the land is restricted by the lease document; provided that:

(1) Fair market value shall be determined in conformance with the uniform standards;

(2) Any disputes over value shall be settled by procedures under this chapter and not by arbitration; and

(3) Any other provision or remedy afforded any class of lessee in this chapter or in any other law relating to the lease of real property shall be equally available to all lessees; and no provision, right, benefit, or remedy afforded to any class of lessee or tenant by this chapter or in any other law or rule shall be denied to any other class, lessee, or tenant.

-3 Rules. The housing and community development corporation of Hawaii shall adopt rules pursuant to chapter 91 as may be necessary to implement this chapter.

-4 Applicability. This chapter applies to all ground leases that were in existence prior to January 1, 1985.

-5 One-time rent adjustment. (a) Any ground lease in existence on the effective date of this chapter that has been renegotiated after January 1, 1990, shall be allowed a one-time adjustment upon application of the lessor or lessee to reflect fair market rental value as determined by a real property appraisal in conformance with the uniform standards; provided that the adjusted rent under this section shall not be lower than the rental amount negotiated pursuant to the lease prior to January 1, 1985. This adjustment shall be a one-time correction to the lease and shall prevail over any existing contract provision to the contrary. The new adjusted rent shall be prospective and shall become effective upon the determination of the fair market rental value as determined by the appraisal. To the extent that the lease rent amount is reduced pursuant to this subsection, a sublessor shall promptly adjust any sublease to a sublessee for the premises or portion thereof covered by the sublease to the extent necessary to achieve fair market rent. This subsection shall be automatically repealed on December 31, 2006, or three years after a final court decision upholding the validity of this chapter in the event the validity of this section is challenged, whichever occurs later.

(b) At the option of either party, any disagreement over fair market value that cannot be resolved by negotiation shall be settled by an appraisal process that is in conformance with the uniform standards, and shall not be subject to arbitration under chapter 658A and any amendments thereto.

If a party does not agree with the value produced, the party may appoint and pay for the services of an appraiser of its choice, who shall perform an appraisal. If the two appraisers cannot resolve the differing valuations, a third appraiser shall be appointed by mutual agreement to review the work done or, failing agreement, by the senior judge of the circuit court of the circuit in which the real property is located, and the issue shall be settled by a decision of two of the three appraisers. All appraisers shall provide in writing their findings, conclusions, methodology, and reasoning clearly showing how they arrived at their decisions. The cost of the third appraiser shall be divided and paid equally by the lessee and lessor.

(c) As used in this section, "ground lease" means a lease of privately-owned land in which a lessee leases the land only or leases the land and infrastructure for a term of twenty years or more, including extensions and renewals.

-6 Priority. If this chapter conflicts with another state law, this chapter shall prevail.

-7 Severability. If any provision of this Act, or the application thereof to any person or circumstance is held invalid, the invalidity does not affect other provisions or applications of the Act, which can be given effect without the invalid provision or application, and to this end, the provisions of this Act are severable."

SECTION 3. Section 519-1, Hawaii Revised Statutes, is amended to read as follows:

"[[]519-1[]] Lease renegotiations; calculation of rent; definition. (a) Whenever any agreement or document for the lease of private lands provides for the renegotiation of the rental amount or other recompense during the term of the lease and [such] the renegotiated rental amount or other recompense is based, according to the terms of the lease, in whole or in part upon the fair market value of the land, or the value of the land as determined by its highest and best use, or words of similar import, [such] the value, for the purposes of determining the amount of rental or other recompense, shall be calculated upon the use to which the land is restricted by the lease document[.

(b) The term "lease",]; provided that provisions of this chapter are superseded by chapter .

(b) As used in this section:

"Lease," "lease agreement", or "document" [as used in this section,] means a conveyance leasing privately-owned land by a fee simple owner as lessor, or by a lessee as sublessor, to any person, for a term exceeding five years, in consideration of a return of rent or other recompense[.], and, for purposes of determining renegotiated rents, shall include any related documents including offers to lease, applications, or documents of similar import which show agreement or understanding as to the use to which property would be put under a lease."

SECTION 4. If any provision of this Act, or the application thereof to any person or circumstance is held invalid, the invalidity does not affect other provisions or applications of the Act, which can be given effect without the invalid provision or application, and to this end the provisions of this Act are severable.

SECTION 5. Statutory material to be repealed is bracketed and stricken. New statutory material is underscored.

SECTION 6. This Act shall take effect on July 1, 2003.

INTRODUCED BY:

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