Master leases are a common tool for companies or individuals that want to invest in real estate. This single tool can help you grow a cash-flowing portfolio, even if you’re just getting started without any money. In this article, I’ll explain how a master lease works, what they can do for your business, and how they can help you scale.
A master lease in real estate is an agreement where an investor leases a property as a single tenant, and then subleases the same property to sub-tenants. The master lease can be used for multiple real estate arbitrage properties or just a single property, like Airbnb arbitrage (also referred to as rental arbitrage).
Although the term “master lease” sounds complex, in reality, this type of lease is very simplistic.
An investor finds an off-market property for sale or a property for lease. Then the investor negotiates with the seller/landlord to try a master lease option. The investor may offer a down payment on the property or get the property for no money down.
Once the lease is signed, the investor has the same rights as the property owner, without legally owning the property. That means you can raise rents, make renovations, or expand as you see fit. In return, you’ll pay the landlord/legal owner rent payments until you purchase the property OR until the master lease expires.
Remember, as the tenant on the master lease, you’ll be responsible for paying the bills. That includes taxes, insurance, maintenance, and more. You essentially own the place!
More often than not an investor tenant (like you) will negotiate a buyout option before signing the lease, allowing you to purchase the property at a certain date or once you have the funds.
So what type of master lease should you sign?
Most master leases will follow the same type of structure. But, creativity can be your friend when negotiating a potential real estate deal. The two types of master leases you’ll become most familiar with are:
The type of master lease you choose is entirely based on the landlord/seller and what it takes to close the deal. This is creative financing at its best, so don’t be surprised if the landlord/seller wants some added profit for their troubles.
A master lease is a tool that works for you and the seller. Some sellers will prefer a master lease over a sale for the reduced tax implications. If you do need to convince a seller that the master lease can work for their situation, try offering these reasons:
For a buyer, especially one without a 20% down payment lying around, the master lease is one of the best ways to creatively finance a deal. Here are some more added benefits:
By this point, you may be feeling the love for master leases. But, before you sign on the dotted line, know that there are some downsides for investors and sellers.
A simple example of a master lease agreement is Airbnb arbitrage (often called rental arbitrage). This practice is when an investor finds a long-term rental, rents it at market price, and then subleases it to tourists at a (far higher) nightly rate. The investor gets paid the difference between the rent cost and how much they collect from nightly rentals, and the landlord gets their agreed-upon long-term lease amount.
Another common example are properties like shopping malls. The mall may have been built by a builder/investor, who subleases the entire mall to another investor who then rents out each individual storefront to a tenant. The investor then pays the property owner a set rate and makes a profit through the difference between his tenant’s combined rent and what he owes to the owner.
In other words, a master lease can be thought of as real estate arbitrage on someone else’s property for your benefit!
Before you run off to the apartment complex down the street, you should know a few key tips when structuring your master lease.
The buyout option in a master lease is arguably the most important clause to add. This gives you, the investor, the option to buy the property from the seller at a given date in the future, for a set price. This protects both you and the seller from leaving each other high and dry toward the end of the deal.
Like any other type of real estate deal, it’s best to know your exit strategies before you start. Understand how long it’ll take you to lease up the property, make repairs, and get it into financeable shape. Set your time horizon so it makes sense for not only you but the deal. This means the master lease could last anywhere from three to ten years, depending on what you and the seller are comfortable with.
The seller most likely wants a headache-free transaction. Part of that deal means you doing most (if not all) of the property management. Remember, a master lease gives you the same responsibilities as an owner. So getting repairs done, tenant turnover, and everything else in between is your responsibility. Let the seller know about this and put their mind at ease before the lease is signed.
So now you know what a master lease is, how it works, the benefits, and the drawbacks of it as well. But how do you structure a master lease to fit your perfect deal?
First things first, know what type of property you’re going after. Are you looking for a single-family home, a multi-unit apartment complex, a self-storage facility, or a commercial space? Pick your niche, know your strategy, and start looking for property potential.
Outdated, underpriced, or mismanaged (often messy) properties may be some of the best to try this strategy on. This is because a property like this will often be neglected by an owner who wants out of it.
If you’ve found a property that meets your above criteria, it’s time to talk to the seller. Be upfront about what your plans would be with the property, how a master lease would benefit the seller and hit home on how this is a low-stress, low-involvement, almost completely passive option for them.
If you’ve gotten a verbal commitment from the seller, start running the numbers. How much will this property need to be fixed up? What are the fixed expenses? What variable expenses can you forecast? And finally, ask yourself how long it will take until you can buy the property from the owner (if that’s your prerogative).
If the math checks out, it’s time to hire an independent inspector. Before you do, let the seller know that you will be doing this. You do not want to catch someone by surprise when sending someone to look through the ins and outs of their property.
Hire a legal professional to draft up a master lease for you and the seller. Be sure to ask them to add a buyout option at the price and date that you and the seller have agreed to. Once this is written up, send it to the seller for review, and get it signed.
Side Note: Lawyers aren’t as expensive as you think. These types of contracts can be drafted for as little as $200. So don’t use some random template from the internet!
If your inspection has highlighted some worrying repairs needed, speak to the seller to see where you can meet in the middle. If they aren’t willing to offer repairs, they may be willing to lower the future purchase price, waive a down payment, or offer other consolations.
If you’ve made it up ’til here, then you’re ready to sign away. Get the contract finalized, sign, and start making rental property profits!
Master leases can be a useful tool for investors who want to take advantage of the benefits of leasing without sacrificing the flexibility or control that comes with ownership. We hope this guide has given you some insight into what master leases are and how they work. So get out there, find your next real estate investment property, and get that cash flow flowing!