As a new real estate investor, you might think it’s impossible to buy a large-scale apartment building or a commercial property. It would take a huge down payment, great credit, and a steady income to make those huge monthly payments… right? Well, don’t give up so fast. With some creative financing, you can land the commercial property of your dreams!
Master lease options, also called master lease agreements, allow you to buy a commercial property with a low (or even non-existent!) down payment.
“Creative Offers Welcome”
When you see those three words on a real estate advertisement, jump on it! When a seller welcomes creative offers, you’re highly likely to come up with a master lease agreement that benefits both the buyer and the seller. Other great phrases to look for are “bring all offers,” “investor wanted,” or even “master lease option available.”
So, what are the benefits of a master lease agreement? What are its downsides? Read on to find out!
Master Lease Benefits for the Buyer
As the buyer, you’ll get to purchase and own a commercial property quickly with no banks, no lenders, and very little money out of your pocket. There is less risk because the loan is still in the seller’s name, yet you maintain control over the property. You’ll basically become the tenant of the property. You will then sublease the property to occupant tenants and receive all cash flow above the lease payment, earning you steady cash flow as long as you can rent it out for a higher price than the lease payment. As you work to improve the property, its increase in value becomes yours, and once you sell it, you’ll profit from every dollar above the master lease agreement price. In most cases, you’ll get the option to buy the property at a pre-fixed price after a set number of years. And if you choose not to buy at the end of that term, there are no strings attached… you can just walk away. Sounds great, right? It really is!
Master Lease Benefits for the Seller
There are fewer benefits for the seller than there are for the buyer, but that doesn’t mean it’s impossible to find a seller who is willing to work with you. Sellers who enter a master lease agreement are usually tired of managing a property and want to offload it to someone with more time and energy. Maybe they live out of state, maybe they’re approaching retirement age, or perhaps the property is distressed and they don’t know how to fix it. When they enter a master lease agreement, the seller won’t have to deal with the day-to-day operation of the property anymore—that’s your job. They’ll receive lease payments each month based on the equity of the property, so they’re still getting a steady flow of income from the property with none of the headache of managing it. And, when the term is up, they’ll be able to sell the property quickly and easily to a great buyer (you)!
A Sample Master Lease Scenario
Let’s say there’s a 12-unit apartment building in your town. It’s in a decent location, but it needs some TLC. It looks outdated and dirty, and there’s a vacancy that hasn’t been filled in months. The seller wants to offload it because he isn’t making as much money as he used to from it—plus, he’s just tired of dealing with it. He’s had problems communicating with his property manager and the building hasn’t been maintained very well over the last year or two, causing the value of the property to drop. He wants to sell quickly, but his price is just a little bit high for you… and he’s not backing down.
You call up the seller and offer him a deal: You’ll lease the property from him with an option to buy it in 5 years. Each month, you’ll make a fixed lease payment to him. The lease payment will be enough for him to pay his mortgage, insurance, and taxes plus some extra money to sweeten the deal. He won’t have to take care of any of the management of the property, though it will still be in his name. He agrees to the deal!
Once you have control of the property, you get to work improving it. You update the exterior, clean it up, fill the vacancy, and increase rent. You’re still paying the seller each month, but now you’re making a little bit of profit off the property each month, too! By the time the 5 years are up, you’ll be able to own the property—and it’s performing far better than ever. Congrats—you’re the owner of a multi-family building without even making a down payment!
The Potential Downsides of a Master Lease Agreement
Every good thing has its downsides, too. Here are the things to consider before you make a master lease agreement.
- You must hire an attorney— This isn’t necessarily a downside if you have a good real estate attorney, but it is something to be aware of. You’ll need an attorney to create the agreement. There are master lease agreements available online, but we don’t suggest using those because the laws can vary by state and change from time to time. An attorney based in your state who has extensive knowledge of real estate matters is your best bet.
- You risk foreclosure by seller if you don’t follow the terms of the agreement— It’s easy for the seller to foreclose if you don’t hold up your end of the deal. If you’re late on a payment or don’t pay your taxes on time, it could all be over. Keep this risk in mind as you enter a master lease agreement.
- A due on sale clause could occur— If a due-on-sale clause is triggered when the seller transfers the property over to you, you’re responsible for the repayment of the remaining balance of the loan.
- Problems with the seller may occur— Sometimes, it’s hard to convince a seller to enter a master lease agreement. They might be confused about it or there might not be enough incentive for them to do it. Even after they agree to it, there could be issues with them down the road. You’re going to have to deal with them for a few years. At best, these issues could cause headaches and at worst, they could jeopardize your investment. For example, what if the seller isn’t making their mortgage payments? If they don’t pay up, you could lose the property at no fault of your own.
- Large expenditures might prove tricky—If something happens to the property and you need to spend a large amount of capital to fix it, who’s responsible? You or the owner of the property? This is something that needs to be worked out ahead of time to protect both you and the seller.
- You’ll need to plan an airtight exit strategy— You never know what could happen in the future. This means you need a strong and detailed exit strategy thought out in advance. This is one of the trickiest parts of planning for a master lease agreement.