Is not having enough capital the only thing holding you back from investing in real estate? You’re not alone. However, that doesn’t mean you should quit your goal of buying a rental property or delay making an investment until you have the money. There are countless rewards of real estate investing that you can reap with little money or even without having to make a down payment on a property. One of the best real estate investment strategies is called the master lease strategy. In this blog, we explain what a master lease is, how it works, and the benefits of using a master lease plan as a pathway to investing a real estate. Let’s get started.
What Is a Master Lease Agreement?
A master lease in real estate is an agreement where you lease an income-producing property as a single tenant and then sublease it to occupant tenants to get rental income. Under the master lease option, the owner of the property will have no other responsibilities for the property. You (the lessee) will be given an “equitable title”. This means even though the owner still technically owns the property, you have the permission and right to modify and manage it however you wish for a period of time. For example, you can renovate it to add value and charge higher rents from the occupant tenants for the higher-quality space. There are two most widespread types of master lease agreements. These are:
- A Performance Master Lease: this requires the lessee to pay a percentage of the profits he/she receives from his sub-resident only after he/she receives those profits.
- A Fixed Master Lease: this generally requires the lessee to pay a percentage of the profits even if he/she does not have a sub-resident.
There are many hybrids, of course, given that each property owner has different needs. As a real estate investor, you can negotiate any and all aspects of your master lease. This includes the fixed rent amount, the lease terms, the liability for expenses, escape clauses, etc. When done right, you can increase the cash flow from the rental and pocket the difference between your master lease payments are and the rent you’re collecting. Hence, you can invest in a property (commercial or residential) without a down payment and without using a lender. Therefore, a master lease option (MLO) is an ideal solution for those who have little capital or a less than perfect credit score.
How Does a Master Lease Work?
Based on the definition, you can already tell how a master lease works. But to put it into steps to explain it even further, here’s how you can implement this creative real estate investing strategy:
- You, the buyer or real estate investor, pay a small (and in some cases no) down payment to the current rental property owner (the seller). Remember, we’re talking about income-producing properties like multi-family real estate.
- You receive the permission and rights that come with owning and operating the property. Sometimes, the seller will also give the lessee an option to buy the property at a set price (the MLA price) within a fixed period.
- Next, you’ll have to pay regular lease payments for the life of the master lease or until the purchase date, whichever is sooner.
- You become in charge of managing and maintaining the rental property, including paying utility bills, annual insurance premiums, and property taxes.
- As mentioned, you can increase the property’s value with improvements and upgrades. Accordingly, any resulting increase in tenant rents flows directly to you.
- You’ll receive all profits, namely the cash flows after deducting the regular lease payments and expenses.
- The buyer or real estate investor also receives all tax benefits from the rental property.
- Finally, if you execute your option to buy, you’ll receive the legal title to the property at closing.
Benefits of Master Leases for Investors
The benefits to the lessee or buyer are plenty. The most obvious one is that once the rent is paid, any profit made goes directly to you. There’s already the already-mentioned benefit of not having to put down any money on the property to acquire it. Because you don’t need to take out a loan, the master lease agreement proceeds without involving a bank or private lender. As a result, it’s one of the simplest ways to get into real estate investing and the risk is very low. Master lease in real estate also allows you to give the property a test drive before deciding whether or not to buy it.
Moreover, the buyer or investor can also reap the benefits of any real estate appreciation in three ways. First, as the property gains value, you can raise rents and keep the extra profit. Second, the increase in property value above the MLA price represents your equity in the investment property which serves as part of your down payment when buying the property. Third, you can execute the option to buy the property at the MLA price and then sell it for capital gains. This is also a great way to build a relationship that leads to future purchases and often owner financing.
However, one thing to keep in mind is that when implementing a fixed master lease plan, you’ll have to pay the rent to the property owner even if your subtenant stops paying you rent. Buyers or lessees might also have varying cash flow due to unexpended repairs that can lead to negative instead of positive cash flow. If this caused you to default on the master lease plan, the property seller can easily take back possession of the property since he/she still holds legal title. Investors can mitigate this risk by conducting a home inspection and running a rental property analysis before master leasing the investment.
Tips for Securing Master Lease Agreements
As mentioned, the master lease agreement in real estate is the result of a negotiation between the property seller and buyer. Here are 5 tips for investors to help ensure the success of the MLO:
#1 Find the Right Seller
The most important factor for successfully implementing the master lease option is finding the right seller. As you can expect, not all rental property owners will agree to the MLO. Thus, you need to know exactly who you can approach for this strategy. While you can approach any owner, there are certain owners who would be more open to the idea. The common reason an owner will be motivated to accept a master lease agreement is that he/she is simply tired of managing the rental and don’t want to deal with tenants and repairs anymore.
Another type of owners you should approach are those out-of-town owners who want to sell for a specific price but can’t achieve that price in the current market. Their motivation is to achieve that number and might not necessarily need all the cash today. One more reason why someone will be open to accepting an MLO is if they have inherited a property and have no idea how to manage it. The point is, if the motivation is right and your offer is compelling, the right seller will agree to the master lease option.
You can find property owners and contact them using Mashvisor. One of the tools we provide for investors is called Mashboard. There, you’ll find homeowner data and information. You can either search up the owner of a specific property that you’ve found by entering its address, or search up property owners in an entire market. You’ll get data including the owner’s full name, contact info, address, age, gender, marital status, and more. You can also filter results by a number of different criteria like the city, property type, and budget. Watch this tutorial to learn how to use Mashboard to find property owners and their data.
#2 Run a Rental Property Analysis
As stated, you need to analyze the investment property you’re interested in before approaching the owner. This will help you assure that you’ve found a rental property that will actually generate positive cash flow in order to make profits after paying rent to the owner. Mashvisor’s Investment Property Calculator automates this analysis and provides you with the data you need to make an investment decision.
For example, say that you’ve found a multi-family real estate property and want to master lease a number of its units. When analyzing this property using Mashvisor, you’ll get data including not only the property’s cash flow, but also its monthly rental income, expenses, cap rate, cash on cash return, and occupancy rate. This property data makes you certain that you’ve found cash flow properties to invest in.
Mashvisor’s Investment Property Calculator
To start looking for and analyzing the best investment properties in your city and neighborhood of choice, click here.
#3 Have a Real Estate Attorney
Each state has its own contract laws and real estate laws that should guide the language used in the master lease agreement. It’s important that you don’t use a generic lease agreement template – some beginners buy such templates from office supply stores or online sources. However, this is never a good idea. Instead, investors must always use an attorney for such matters. A qualified real estate attorney will draw up the master lease agreement form that is appropriate for the state where the property is located.
#4 Follow Legal/Protection Measures
When implementing the master lease strategy, the lessee or buyer should utilize a title company to conduct a title search. This ensures that the property seller has clear title to the property and that no undisclosed liens exist. You also must hire a holding company to secure the original master lease agreement document and the executed deed. Also, you should record with the appropriate agency that the property has a master lease agreement. And lastly, establish an escrow account with the title company responsible for paying taxes and mortgage (if any) on time.
#5 Have an Exit Strategy
Every real estate investor has to develop a well-reasoned strategy specifying how you will exit the MLO. You can do this by either executing the buy option, renewing the master lease option, doing a 1031 exchange, or walking away from the deal.
In summary, a master lease option is a great way for beginner real estate investors to get started in building their investment portfolio. It doesn’t require loads of money for a down payment, experience, or a great credit score. What could be better than that? If you have any questions about this real estate investment strategy, feel free to leave them in the comments section below.
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