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Master Lease and Sublease Agreements for Real Estate Investors

A master lease can solve a number of real estate investment pain points, but there are considerations investors must understand.


[Updated: Feb 04, 2021 ] May 01, 2020 by Brad Cartier
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Master lease agreements (MLAs) solve a number of potential pain points for real estate investors. So what is a master lease? This type of legal contract allows the lessee to sublease and control a real estate asset for a prescribed period of time. In downturns, this strategy can be particularly appealing to those seeking to acquire or liquidate properties when sale prices and values sink.

There are several scenarios where a master lease makes sense, not just for investors holding assets but for those looking for creative acquisition strategies as well. Here's an overview of master lease agreements and how they can benefit both buyers and sellers of real estate investment assets.

What is a master lease and sublease?

There are many types of leases available to real estate investors. The master lease agreement is just one tool in your real estate investing toolbelt.

A legal team is invaluable when considering a master lease option, and legal requirements may vary by jurisdiction. That said, here is how a master lease generally works for real estate investors:

  • A property is purchased with a small, or no, deposit.
  • The lessee (buyer) gains "equitable title" to the property. The seller retains "legal title."
  • The sublease lessee is entitled to use the property in any way outlined in the lease. Typically, this involves access to cash flow, subletting, tax benefits, appreciation, and profits as set out in the master lease agreement.
  • The lessee is responsible for all management, maintenance, and expenses (utilities, property taxes, etc.) associated with the property.

Optional: An option to buy the property outright can be written in a master lease agreement. This gives the lessee legal title and can be executed at certain milestones in the master lease.

Because the lessee of the master lease can still increase the value of the asset through value-add strategies, lessees are typically entitled to all appreciation and cash flow of the property.

When to use a master lease

The use of a master lease and sublease can be appealing under a number of circumstances. Here are a few that may apply:

Seller can't get fair market value

For instance, if a seller cannot obtain fair market value (FMV), they may choose to enter into a long-term lease agreement with a lessee, who commits to purchasing at the desired price in the future.

Distressed or vacant units

Value-add investors can seek out distressed or vacant assets for acquisition by contacting the current landlord to discuss the benefits of a master lease. In this situation, the landlord is getting their asset rehabbed and stabilized and setting monthly payments and has the ability to sell the property at a future date at a pre-established price. For the lessee, they get a new asset likely at a discount with minimal down payment.

Taxes

A master lease agreement is a great way for sellers to avoid a large capital gains liability that would be payable upon sale. A master lease allows a seller to avoid a traditional legal sale but still maintain monthly payments over the long-term.

Out-of-town investors

Out-of-state investors may be eager or open to partner with someone on the ground who may be in a better position to manage their assets. This is true for both long-term buy-and-hold investors as well as owners of any short-term rental, such as Airbnb hosts or hotels. A master lease allows lessors to retain legal title, lowering their risk, as well as rent and income certainty through monthly payments.

Closing costs

The closing process for a master lease agreement on real estate assets is less burdensome than a traditional real estate sale. Further, closing costs are lower.

Operating businesses

Landlords of commercial real estate and operating businesses, such as hotels and short-term rentals, may want an exit strategy for themselves. An investor coming in offering a master lease agreement gives the current landlord an opportunity to step back from the day-to-day operations but still maintain income without the tax burden of a sale.

Master lease terms

As with anything in real estate investing, negotiating a good contract can make or break your investment. This is why it's critical to consult with your legal team, who can draft master lease terms that best suit your situation. Here is what you typically find in a master lease agreement:

  • Property description.
  • The master lease term.
  • Payment structure to master lease holder.
  • Rent, income, and expense responsibilities to master tenant.
  • Acceptable use of the property.
  • Capital improvement rules.
  • Maintenance requirements.
  • Record keeping.
  • Return of property timeline.
  • Option to buy.
  • Default remedies.
  • Escrow account details.

For more, you can review an example of an executed master lease on the Securities and Exchange Commission's (SEC's) website.

Example of a master lease scenario

Let's say you found a 20-unit apartment building in a gentrifying neighborhood. This asset has had high vacancy for the last 90 days, but you believe in the long-term viability of the asset's location. In your due diligence, you discover the owner is an out-of-town investor, has a second loan on the property, and was late on a property tax payment the previous year.

You contact the owner and discover that even though they are generating $1,500 a month in cash after expenses, the high vacancy and tenant management has them ready to listen to your master lease proposal.

You offer the owner a $1,000 monthly payment for the first 12 months as you rehab and stabilize the multifamily asset. After 12 months, you propose to give the owner $2,000 a month for a 5-year period, with the lease option to purchase the apartment at today's FMV at the end of the lease. If the owner were to sell today -- which they admitted considering, but high vacancy reduces the appeal of their property -- they would certainly not obtain FMV.

This is a potential win-win for all involved: The lessee could potentially benefit from the upside of higher rents and lower vacancy after rehabbing the property and has the option to acquire the property in the future at today's FMV. On the other side of the deal, the lessor gets an upgrade on a poorly producing asset without putting up capital, gets rent and income certainty during the rehab process, and can still maintain legal title in case anything were to go wrong with the lessee.

The success of the master lease agreement model is entirely dependent on the lessee's ability to rehab the property, stay on budget, and stabilize rents in the medium term to produce higher returns.

The bottom line

A master lease agreement can be a unique way to solve a number of real estate investing problems. For entrepreneurial investors, a master lease scenario is a great way to acquire portfolio assets. For current owners, a master lease can allow you to better stabilize your property and provide a long-term exit strategy.

As with any legal agreement, it is critical for investors to consult their legal-team advisor prior to entering into a lease agreement.

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