What is a Master Lease?
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Different Types of Master Leases
Broadly speaking, there are two common types of master lease agreements:
- Performance master lease agreements require the master resident (lessee) to pay the owner a percentage of the rents they collect from subleasing the property.
- Fixed master lease agreements require regular lease payments regardless of whether or not the property is subleased.
When dealing with commercial properties, the terms of a master lease can be structured in different ways to ascertain the financial responsibilities of the owner and the lessee. For example, a commercial master lease can be structured as:
- A gross master lease in which all costs associated with the property (utilities, maintenance, janitorial) are lumped into the rental fee; the lessee only pays taxes and insurance.
- A triple-net master lease in which the lessee assumes operating expenses (taxes, insurance, and utilities) in addition to rent.
- A double-net master lease in which the lessee pays a portion of taxes and insurance in addition to rent.
- A single-net master lease in which the lessee pays rent and a share of property taxes.
Lease arrangements always involve an element of negotiation between the parties; this is especially true in commercial real estate deals. Elements such as rent payments, expenses, and term of the master lease can be customized to meet the needs of the owner and master resident.
Investors who are short on capital may be able to get into income-generating properties using a master lease agreement.
What Are the Advantages of a Master Lease?
For the lessee, the main advantage of a master lease is that it allows an investor to get into an income-generating property without a significant outlay of capital. The master resident does not need to put up a sizable down payment or take on debt to control the use of a property. This lets an investor realize cash flow without risking significant capital. A master lease is also an option for investors who lack the credit profile to obtain traditional financing.
Owners also benefit from steady rental income without the additional responsibility for managing and maintaining a property. Any improvement a master resident makes on the property reverts to the owner at the end of the lease. In addition, because the owner retains legal title, they are also entitled to tax deductions associated with it.
What Are the Disadvantages of a Master Lease?
As the master resident, the lessee has the first payment responsibility to the landlord. Whether or not they successfully sublease the property, the fixed rent payment is still due. Of course, this risk is not unique to master lease agreements; if a property is financed, debt payments are still required even if the property is vacant.
The master resident also has a legal liability to tenants. In a residential lease, some jurisdictions have stringent tenant protections, although this can also work to the investor’s advantage in disputes with the owner/landlord.
In commercial leasing, there are usually fewer laws governing the lessee/lessor relationship, which means fewer protections. In addition, commercial leases tend to have much longer terms than residential leases, which may add to the investor’s risk.
What Is a Master Lease With Option?
The master lease with an option is an agreement with an option to buy the property outright at some predetermined future date. The lease can be structured to allocate a portion of the rent payments toward the property’s purchase price.
Most master lease agreements contain an option to buy the property. This may actually be a cheaper option than hard money financing for investors who plan to refinance the property in a short time. It also avoids many of the costs associated with financing, such as loan origination fees that can run as high as 5% for short-term loans.
Capital appreciation is another significant but overlooked advantage for lessees in a master lease with an option agreement. First, as the property increases in value, the lessee can increase rents. Second, any increase in property value over the term of the lease adds to the investor’s equity when they exercise the option to buy. They can then turn this equity into capital gains by immediately selling the property after purchasing with a double-closing.
Tips on Using a Master Lease Agreement
There is risk involved in every real estate transaction, but an investor can limit their exposure by following these best practices for master lease agreements:
- Although an investor can download a master lease agreement template (see below), these forms do not replace the services of an experienced real estate attorney. Each jurisdiction has its own real estate laws and requirements. It is essential to have a lawyer review—if not draft—the master lease agreement to protect the investor’s interests and minimize legal exposure.
- Pay attention to due diligence. Get an inspection, engineer’s report if necessary, and a professional appraisal. If the master lease agreement includes an option to buy, get a title search to ensure there are no clouds on the title.
- Have an exit strategy in place, whether exercising the purchase option, renewing the master lease agreement, or executing a 1031 exchange.
- Verify that the master lease is recorded with the appropriate government agency and open an escrow account with the title company to handle tax payments outlined in the master lease agreement.
Where to Find a Master Lease Agreement Template
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Downloadable master lease agreement templates are available at the following sites:
A master lease is a way for investors to get into income-producing property without putting up an excessive amount of capital. The seller grants the lessee equitable title to the property in exchange for monthly rent payments. Most master lease agreements include an option to buy the property outright once a certain milestone is reached.
- Smyth, D. (2019.) What Is a Master Lease Agreement? BizFluent. Retrieved from https://bizfluent.com/facts-5729491-master-lease-agreement-.html
- Real Estate Investing Association. (2020.) The Benefits of a Master Lease Option. Retrieved from https://reinvestingassociation.com/benefits-master-lease-option
- 1031 Exchange Made Simple. What is a Master Lease? Retrieved from https://www.1031exchangemadesimple.com/master-lease.html