Master lease agreement involves two key players: the lessor (landlord), who owns the historic property and handles renovation costs, and the lessee (master tenant), who leases the property, sublets to tenants, and covers operating expenses.
Before diving into the pros and cons, let’s explore these structures in detail.
What Is A Master Lease Agreement
A Master Lease Agreement is a contractual arrangement between two parties, typically a property owner (lessor) and a tenant (lessee), where the lessee gains control of the property and assumes responsibility for managing it, often subleasing portions of it to third parties.
This agreement allows the lessee to operate and profit from the property without owning it outright, offering flexibility and potential cost savings compared to traditional lease agreements.
Different Types of Master Leases
In essence, two primary types of master lease agreements are:
- Performance master lease agreements entail the lessee paying the property owner a percentage of sublease rents.
- Fixed master lease agreements involve regular lease payments regardless of property subleasing.
In commercial properties, master lease terms vary, determining financial responsibilities. For instance:
- Gross master lease: All property costs are included in the rental fee, except taxes and insurance.
- Triple-net master lease: Lessees cover operating expenses (taxes, insurance, utilities) along with rent.
- Double-net master lease: Lessees pay a portion of taxes and insurance in addition to rent.
- Single-net master lease: Lessees pay rent and a share of property taxes.
Negotiation is key in lease agreements, especially in commercial real estate. Rent, expenses, and lease terms can be tailored to suit both parties. Master lease agreements can provide an entry point for investors lacking capital in income-generating properties.
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Typical Sections in Master Lease Agreements
Here are typical sections found in Master Lease Agreements. These sections are linked to the sample agreement below for further exploration:
- Lease; Term; Non-Interference
- Rent
- Net Lease; Disclaimer of Warranties
- Use; Maintenance; Location; Inspection
- Loss and Damage
- Lessee Representations and Agreements
- Insurance
- Indemnities; Taxes
- Return
- Remedies
- Title; Property; Additional Security
- Default
How Does Master Lease Agreement Work?
Based on the definition you read above, you can probably guess how it works. But we like having everything in written, so we put it into steps to explain it even further. Here’s how you can implement it:
- Agreement Structure: The landlord and the master tenant enter into a master lease agreement. This agreement outlines the terms and conditions of the lease, including rent amount, lease duration, responsibilities of each party, and any other relevant provisions.
- Subleasing: After obtaining control of the property through the master lease, the master tenant can sublease all or part of the property to subtenants. This allows the master tenant to generate income by charging subtenants rent that exceeds the amount paid to the landlord.
- Rent Payments: The master tenant pays rent to the landlord based on the terms of the master lease agreement. This rent amount is often fixed, but it can also be structured as a percentage of the sublease income generated by the master tenant.
- Sublease Management: The master tenant assumes responsibility for managing the subtenants, including collecting rent, maintaining the property, and addressing any issues that may arise during the sublease period.
- Property Operation: While the master tenant is responsible for managing the property and subleasing it, the ultimate ownership and legal obligations remain with the landlord. The landlord typically retains ownership of the property and may still be responsible for certain expenses such as property taxes, insurance, and major repairs.
Overall, a master lease arrangement allows the master tenant to control and profit from a property without owning it outright, while providing the landlord with a guaranteed income stream and potentially reducing their management responsibilities.
Advantages of a Master Lease Agreement for the Buyer
- Financial Efficiency: By bypassing the need for a down payment, the buyer saves on upfront costs while still accessing ownership benefits. This option is particularly beneficial for investors lacking sufficient funds or credit for a conventional purchase. With no loan involved, the agreement proceeds without bank or private lender intervention.
- Cash Flow Management: Buyers retain all surplus monthly cash flows after fulfilling the master lease obligation and covering expenses. Efficient property operation can enhance net operating income, leading to increased cash flows for the buyer.
- Property Appreciation: Buyers can capitalize on property appreciation in multiple ways. Firstly, rising property value allows for rent increases, generating additional profits. Secondly, the increased value above the master lease agreement price contributes to the buyer’s equity, serving as part of the down payment for property acquisition. Lastly, the buyer has the option to purchase the property at the agreed-upon price, potentially selling it for a capital gain through a simultaneous double closing.
- Effortless Closing: Property sales can be swiftly finalized, often within seven days, with minimal closing costs.
Advantages of a Master Lease Agreement for the Seller
- Revenue Stream: The seller enjoys regular monthly lease payments.
- Relief from Management: The seller is relieved of property management responsibilities.
- Efficient Closure: Property transactions can be swiftly and cost-effectively concluded.
- Security: Retaining legal ownership allows the seller to reclaim the property promptly in case of buyer default on the lease agreement.
Example Of Master Lease Agreement Deal
Consider a $5 million retail complex at 60% occupancy. Ideally, it could yield an NOI of $600,000 if fully leased. With only $1.5 million available, you opt for a master lease agreement (MLA) at a $5 million price, avoiding a down payment.
You invest $500,000 to enhance the property, expecting its value to rise to $7 million in two years. Exercising the purchase option at $5 million, you secure a $5 million loan, adding $500,000 cash and $1 million equity. After improvements, you sell for $7 million, repay the loan, and net a $1.5 million profit.
