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Many investors understand how rewarding it can be to invest in real estate. At Assets America® we arrange financing for real estate projects with minimum loan amounts starting at $20 million ($20M). But what if you don’t have the resources to make the down payment on a $5 million project, or must overcome less than perfect credit? Logically, you just might be a candidate for using a master lease agreement as a pathway to investing in a real estate project. In this article, we’ll guide buyers and investors on how to use a master lease agreement to purchase commercial property and how to finance your property.
What Is a Master Lease Agreement?
A master lease agreement is a lease with an option to purchase commercial property. In effect, it’s a way to invest in commercial property without a down payment and without using a lender. Happily, both the buyer and the seller can benefit from a master lease agreement.
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How a Master Lease Agreement Works
It works like this:
- You, the buyer, turn over a small (or no) down payment to the current owner (the seller). Of course, we are talking about income-producing property.
- You receive the privileges and rights that come with owning and operating the property. This is done through equitable title rather than legal title, which the seller retains. Also, you receive an option to buy the property at a set price (the MLA price). This would be within a fixed period, regardless of any changes to the property’s value.
- You must pay regular lease payments for the life of the lease or until the purchase date, whichever is sooner.
- You receive all profits, i.e., net cash flows after subtracting the regular lease payments and expenses.
- The buyer receives all tax benefits from the property.
- You are responsible for managing and maintaining the property, including paying utility bills, annual insurance premiums and property taxes.
- You can increase the value of the property with improvements and upgrades. That is, any resulting increase in tenant rents flows directly to you.
- If you execute your option to purchase, you receive legal title to the property at closing.
Benefits of a Master Lease Agreement for the Buyer
The buyer receives several benefits from a master lease agreement:
- Economy: The buyer economizes by avoiding paying a down payment while still receiving most of the benefits of ownership. Specifically, this is useful for investors who have insufficient wealth or credit to purchase the property outright. Because the buyer doesn’t take out a loan, the master lease agreement proceeds without involving a bank or private lender.
- Cash Flows: The buyer receives all monthly cash flows left over after paying the monthly master lease obligation and all expenses. To that end, buyers that can operate the property more efficiently. And the buyer can increase net operating income and enjoy higher cash flows.
- Capital Appreciation: The buyer can reap the benefits of any property appreciation in three ways. First, as the property gains value, the buyer can raise rents and keep the extra profits. Second, the increase in property value above the MLA price represents the buyer’s equity in the property. This serves as part of a down payment on the purchase of the property. Third, the buyer can execute the option to purchase the property at the MLA price. The buyer can then sell the property for a capital gain. You can schedule the purchase and sale simultaneously via a double closing (aka double escrow).
- Easy Closing: The sale of the property can close in as little as seven days. Closing costs are low.
Benefits of a Master Lease Agreement for the Seller
The seller also receives several benefits from a master lease agreement:
- Income: The seller receives monthly lease payments.
- Freedom: The seller is no longer involved in managing the property.
- Easy Closing: The property sale can close quickly and inexpensively.
- Protection: Because the seller retains legal title, it can easily take back possession of the property if the buyer defaults on the master lease agreement.
Tips for Securing Master Lease Agreements
The master lease agreement is the result of a negotiation between a seller and buyer. To help ensure success, observe the following tips:
- Attorney: A qualified attorney should draw up the master lease agreement form appropriate for the state in which the property resides. Obviously, each state has its own contract law and real estate law that should guide the master lease agreement language. Importantly, do not use a generic master lease agreement template. Some lesser experienced buyers try to buy such forms from an office supply store or online source. This is never a good idea. Always use an attorney for such matters.
- Title: Utilize a title company for a title search to ensure the seller has clear title to the property. You want to make sure that no undisclosed liens exist. However, if liens do exist, the title search will identify them. Then, the buyer can understand and deal with those specific matters.
- Holding Company: Hire a holding company to take possession of the original master lease agreement document and the executed deed.
- Recording: Record with the appropriate agency that the property has a master lease agreement.
- Appraisal: Obtain an appraisal and engineer’s report for the property.
- Exit Strategy: Develop a well-reasoned strategy specifying how the buyer will exit the master lease agreement. This can be done by either executing the buy option, renewing the master lease agreement, doing a 1031 exchange. And, of course, you can always walk away from the deal. Undoubtedly, the exit strategy should make conservative assumptions regarding income and equity build-up. Make sure to use reliable research and expert advice.
- Escrow: Establish an escrow account with the title company responsible for paying taxes and mortgage (if any) on time.
Example of Master Lease Agreement Deal
The example property is an apartment building appraised at $10 million, and it is 80% occupied. Furthermore, the property would generate $1 million NOI if fully occupied. Unquestionably, you would like to purchase the building, renovate it and then sell it for a profit. Theoretically, you can purchase it with a loan by putting down 40%, or $4 million. However, you have only $2 million in capital. Ultimately, you agree to a master lease agreement with a five-year term and a $10 million MLA price.
The master lease agreement requires no down payment. Cleverly, your exit strategy is to deploy $1 million to improve the building. You know that its market value will rise to $13 million within three years! At that point, you exercise your option to buy the property for $10 million. Accordingly, you take out a $10 million loan, putting up $1 million in cash and $3 million in equity. After purchase, you sell the property for $13 million, pay off the loan, and pocket a $2 million profit. There would be $13 million in sale proceeds minus a $10 million loan repayment minus $1 million renovation costs.
How to Obtain Commercial Property Loans?
You need financing to execute the master lease agreement purchase option. To a large extent, your financing depends on your exit strategy. For example, if you plan to flip the property, you can arrange a bridge loan. This loan would cover the period between the purchase and resale. Alternatively, if you plan to hold the property for the long term, you’ll need a mortgage to finance the property. Truthfully, you might first need a construction or bridge loan to finance the property renovation. And then you would need a mini-perm loan to stabilize the building. Once stabilized, you can refinance with a take-out loan — a first mortgage.
You could try to identify a bank that will provide all this financing. But you might first have to devote considerable time and effort to identify the best deal available. Thankfully, you can employ a better strategy by using a loan broker like Assets America®. Conveniently, our network of banks and private funding sources compete to get you the best financing possible. And we do this as expertly and expeditiously as possible. Thus, if you plan to invest in a commercial property through a master lease agreement, contact Assets America®. We have a full range of commercial property financing options. Truly, you’ll receive highly, professional service and access to a lending network for loans of $20 million and beyond.