The fact is that home prices are still low from the recent housing market crash. It might have been almost a decade ago now, but many people bought houses just before the housing market crash. They paid a lot for their homes, and now those same residential properties still aren’t worth half of what they were then. So they can’t sell and break even. Home buyers are merely looking for a place to live in most cases, but their options are limited. This has led to a massive uptick of rental prices and rates across the nation. This also makes it hard for people looking for a place to live to find one. The solution for everyone comes in the fashion of master leases implemented by real estate investors.
A Breakdown On Master Lease Investing
A master lease isn’t just outright buying a property from someone. You are creating a contract with them to slowly attain the wealth from them while covering the necessary costs of the property in question but receiving any assets produced by the property. What this means is that you are getting any rent money from tenants, whether it be a residential property or a commercial property.
Targets Of Master Leases
People who want to invest in master leases need to be more than just a little creative. While there is a beauty behind the master lease strategy, it is still a complicated endeavor that requires some finesse in its process. There are a couple of types of homeowners that a master lease investor is looking for precisely. The first is someone who lives out of town who wants to make a sale for a high price that they just can’t get. They want to be rid of the property and to get their money out of it, but they might not care whether or not they get it all now or later.
The second type is homeowners who bought their properties when the market price was high but have no hope of selling now and getting even just their money back, much less a return investment of any kind. They just want to claw their way out of debt because they can’t refinance or sell.
The Many Different Kinds Of Master Leases
While there are actually many variations of a master lease, there are two main types of it. There is the performance master lease and the fixed master lease. As previously stated, there are many variations of both of these depending on the owner’s needs. In essence, a performance master least indicates that the current main resident has to pay a portion of the monetary returns they get from their sub-lessee but only when they get said funds. The fixed lease requires the main lessee even while there is no sub-lessee.
Now, depending on the owner’s wants and needs, a master lease could even be a combo of the two of these in some fashion. The idea for a master lease is to give the investors in them the opportunity to negotiate for their own requirements. This includes everything from rent, liability payments, the escape clauses, and other important items. The main aspect of this is to draft the terms you want to negotiate on with the current owner. This works far better in most cases than the standard realtor lease which is the default option.
Caution About The Risk Revolving Around Master Leases
A lot of real estate investors have deep fears about making leases for a long period of time as the master lessee than they might be of just buying property to invest in. Some say this fear is unwarranted as it is much simpler to separate yourself, as an investor, from a lease than a feature you’ve already bought and paid for entirely. This is why many investment experts say that a master lease is a better strategy in regards to preventing monetary losses in real estate investing.
Another large issue is that many investors like to think that they must be a licensed real estate broker in the state the property is located in to use the master lease strategy. This is usually only true of property management in various states. There are a few exceptions to this rule but not in most of the fifty states of the union. It is true of property management in many states because of their relationship with the principle that is definitely fiduciary. This is not generally true of master leases, and many state and local governments recognize that fact.
Master Leases: The Positives & The Negatives
As with everything in life and especially real estate investing, there are pros and cons to master leasing. Here we go far past just stating the pure definition of a real estate term. So naturally, we’re going to go deep within the positive and the adverse facts about the master lease.
The Test Drive: Master Lease Pros
A long-term but secured lease lacking an option basically resembles a test drive of a property before the lessee decides to buy it or not. It’s definitely a subtle way to do this, and in most cases, the master lessee will choose to purchase the property if they get even close to their expected results. This really works because the owner must negotiate further with the lessee to remove the lease before they can take any financial action like outright selling the property or refinancing the property. It is your foot in the door as an investor to build a good rapport with the owner for future negotiations on terms for the property’s purchase or sale to receive a return investment. The master lease is not the main negotiation but rather the first step towards those future negotiations.
The Risk: Master Lease Cons
So what is the risk of using the master lease strategy? Well, your first payment to the current owner is definitely at risk of being a loss. If the deal falls through at some point, you do not get that payment back in most cases. There is also the fear of homeowners of leasing their property out to you as we mentioned before. With that said, you are also liable to make the rent payment if and when your sub-tenant can’t afford it or if they decide to break their lease and leave. It is a similar risk with owning the property outright and having a tenant. If they suddenly don’t pay the rent, you still have to cover the bills like a mortgage and property taxes. It can also be compared to paying back a lender used to buy investment properties. You will definitely have ups and downs with master leasing. Your cash flow could fall into the negative at times, and it is your responsibility to mitigate this problem to the best of your ability.
Surprise repairs will undoubtedly leave your wallet feeling emptier which is why you should always inspect a home personally before investing in it or taking out a master lease on the house. We said it earlier, negotiation is your greatest tool. Negotiate for repair liability limits in the initial master lease contract. This will save you some time and probably a lot of return investment money later on. With that said, save up some working capital before heading into a master lease agreement on paper. Most properties need some cosmetic work before they can be rented out for a reasonable price. Also, make sure you perform background checks on possible sub-tenants, or you’ll end up in a world of monetary hurt. This is something that all investors and landlords alike have to deal with to be successful. So get used to the idea now.
An Example Of A Master Lease In Action
Say you have a condo that you have had for years, but you had to move for your career. You rent the condo out for a while, and the tenants are good about paying the rent every month on time. However, the repairs that come up are tiring and time-consuming. You’ve got a job in another town that takes up most of your time as it is. So when the tenant leaves you can decide to sell the condo “as is” which is fine. Your only goal is to break even on what you paid for the condo.
Here’s where it all falls apart. The market value of the condo is literally at what you paid for it to begin with and it is not in the same great condition it was in at that time. You get a few offers that are a good fifteen to twenty percent less than what you need to break even and prevent a loss. Finally, someone comes to you with this crazy idea called a “Master Lease.” They’re going to pay you a large percentage down and pay enough monthly to give you even more monthly, and after just a few years they’re going to pay you off completely for the property. Not only do you break even but you even made a little bit of return investment. This is a master lease agreement.
Keep The Lawyer On A Leash
There are times in real estate investing when you may need a lawyer. You might even need one for a master lease. However, if you do need a real estate transaction attorney for a master lease agreement, it is generally taken as a bad sign for the master lease contract as a whole. That usually means that you and the property owner don’t exactly agree on the deal in the first place. A master lease strategy works best when the two can simply negotiate with each other without a third party overseeing the entire process. The idea is to talk it over and just shake on it at the end. After all, you’ll be dealing with each other regularly for a while, so it is best to do so on good terms. This is nothing against lawyers as there are many fine graduates of law school out there. There’s just a few who see their clients as money bags instead of people. They will get involved whenever they can. A lawyer may be welcome for a master lease agreement if the current property owner isn’t savvy to the ways of real estate investing.
Master Lease In Summary
So a master lease is a way of testing an investment property before you fully commit to purchasing it. Either you or the property owner can back out of the deal if need be without suffering any undue loses. It is, in a sense, another way to flip a property and make a profit. While you don’t want to get coined for all of the repairs needed in a real handyman special, you can do a few, pay the owner rent, and still make some capital off of a sub-tenant. While using some caution is always advised, it is a handy way to invest in some fine real estate properties. As far as leasing real estate goes, the master lease is a great option for investors and homeowners alike.
