How a Lease Mortgage Thailand Structure Fixes What Collective Leases Can’t
A lease mortgage Thailand structure addresses all three problems the Collective Lease fails to solve — non-renewal risk, tax exposure from pre-payment, and illegal nominee shareholding — with a simple, legally accurate alternative.
Recent Thai court rulings holding the so-called “collective leasehold” or “secured leasehold” structure (the “Collective Lease”) to be void have created quite a stir among Thai real estate developers and investors. Many developers selling to foreign investors have been marketing and selling the Collective Lease for several years now, so the implications of these rulings could affect a significant segment of Thailand’s real estate market.
A long-term lease is a common means for a foreigner to invest in Thai real estate, largely because Thai law — with limited exceptions — prohibits foreign freehold ownership of real estate. However, under current Thai law the maximum lease term is just 30 years. As a result, it has become common for developers marketing to foreigners to offer a 30-year lease with two additional successive 30-year renewal terms.
Under Thai law, however, any such additional term is not an “extension” of the lease but merely a “renewal” — meaning the new term is essentially a new contract. The result is that if the property’s owner changes during the first lease term, the new owner is not obliged to honor the renewal, even if the lessee already pre-paid the original owner for it.
To address this insecurity, many developers offer the Collective Lease, promising not only a lease but also shares in the Thai limited company that owns the leased land. Other investors in the same development do the same, becoming co-owners of that land-owning, land-leasing company. The idea is that the investors would collectively control the company and thereby ensure that it renews all of their leases for the two successive 30-year terms — “guaranteeing” the investors a full 90 years.
[We have already detailed in previous articles here and here why the Collective Lease does not achieve the security it advertises for foreign real estate investors in Thailand. Now, in addition, two Thai trial court judges and three Thai appellate court judges have held the Collective Lease to be legally void. We have explained those rulings here]. We wish to emphasize that this firm does not agree with the legal holdings of these five judges. However, given that the Collective Lease fails to provide any real security, and that Thai judges are not bound to agree with this firm’s legal opinions, it is unsurprising that real estate developers and investors in Thailand are looking for an alternative that truly secures leasehold investments.
Any alternative must address three issues the Collective Lease fails to resolve: (1) the risk that the lease may not be renewed for a second or third 30-year term; (2) the tax issues created by a lease renewal in light of pre-payment for the commonly marketed 30+30+30 year structure; and (3) the use of illegal Thai shareholding “nominees.” The only alternative that addresses all three is what we refer to here as the “Lease-Mortgage.” It is a simple structure that reflects what is already happening, as a practical matter, in most of these common 30+30+30 year lease agreements in Thailand.
As noted above, these lease agreements are almost always pre-paid in full. However, the two additional 30-year renewal terms can only be granted and effected at the end of each prior term. The current landowner has merely promised to grant these future terms, yet has already received payment for them — which is, legally speaking, a loan. Until money is paid for something actually provided, the law treats it as a loan. In these common structures where a single payment covers all 90 years, two-thirds of that payment is, from a legal standpoint, merely a loan. And the simplest, most reliable way to secure a loan is exactly what banks do: charge interest and register a mortgage against the land.
The Lease-Mortgage does exactly this, providing the accurate legal structure for what is already happening in practice (a lease for the first 30 years, plus a loan for the next two 30-year terms) by adding what should accompany it (interest on the loan, and a mortgage securing it for those two terms). This is achieved by combining (1) the 30+30+30 year lease agreement with (2) a loan and mortgage agreement. Once finalized, the first 30-year lease term is registered on the land, and a mortgage securing the loan for the two additional renewal terms is also registered on the same land.
If the lease is renewed for the second 30 years, that portion of the loan is effectively “forgiven,” since the parties agree it has become rent for that term — no longer a loan, but a rent payment — and the corresponding mortgage is automatically removed from the land. The same applies to the third 30-year term.
However, if the lease is not renewed at the end of the first or second 30 years for any reason, the investor can immediately foreclose on the property, have it sold, and recoup their investment.
Does the Lease-Mortgage address the risk of non-renewal? Yes. The investor’s prepaid investment and interest are secured by a registered mortgage on the land title deed, which remains attached to the title regardless of any change in ownership. If the lease isn’t renewed as required, the investor can have the land sold to recover the investment and interest. Even if the land is transferred, the more likely outcome is that a new owner would honor the renewal term rather than risk a forced sale.
Does it address the tax issues created by the pre-payment structure? Yes. The Lease-Mortgage reflects what the parties actually agreed to: a 90-year total pre-payment covering three successive 30-year terms. Under the Collective Lease, Thai tax authorities will treat full payment as income only for what has actually been provided — meaning, since only the first 30-year term has been delivered, the entire pre-payment could be taxed as income within the first 30 years, decades ahead of when it should be. Worse, the Revenue Department may later assess fictitious rental income for the unrepresented second and third terms; if unpaid, the land could be seized and sold, voiding any renewal rights. Under the Lease-Mortgage, none of this occurs — the landowning company receives the same total amount, but the payment is properly booked as one-third rental income and two-thirds loan. Since loans aren’t taxed, the company benefits from both correctly timed taxation and untaxed liquidity during the first two terms.
Does it address the use of illegal Thai shareholding “nominees”? Yes. A Thai limited company cannot own and lease land unless at least two individual Thai nationals hold shares in it directly or indirectly — but it is illegal for Thais to hold such shares merely as nominees for a foreigner’s benefit. The Lease-Mortgage avoids this entirely, since the investor is never required to become a part-owner of any Thai company to secure their lease.
The Lease-Mortgage is best implemented at the start of a development, before any leases are signed. However, existing developments can benefit from a similar approach using what we call a “Penalty-Mortgage.” Here, the lessor and lessee enter into a Penalty Agreement under which the lessor is subject to a significant Thai Baht penalty if the lease is not renewed as required, with that penalty secured by a registered mortgage on the leased land. As with the Lease-Mortgage, this security travels with the land title regardless of ownership changes, giving existing investors comparable protection.
The simple elegance and accuracy of the Lease-Mortgage and Penalty-Mortgage structures provide uncomplicated security and enhanced resale value for investors, along with greater marketability and other financial benefits for developers.
For developers and investors alike, a lease mortgage Thailand structure like this offers exactly what the Collective Lease only promised — genuine, legally sound security that survives a change in land ownership, without the tax complications or illegal nominee arrangements the alternative requires.