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(By Kevin)
The Power of the Master Lease Option:
Last month I wrote about how you can use a lease option and a sandwich lease option to make profits in real estate.
As a reminder, a lease is simply an agreement to make payments on a property for a specified period of time for use of that property. The option, generally a separate document, is an agreement between the owner to sell the property to the tenant or lessee for a specified price on or before a certain date.
This tool can also be used for commercial property. However if the commercial property has multiple tenants there is another version of this tool called a "Master Lease Option."
The Master Lease Option is one of the simplest ways to enter the commercial real estate investing world. Typically the only cash involved may be for the option fee, you won't need a loan, and you can do this with little experience. Therefore, your risk is very low. In fact, if you manage the property effectively, when it comes time to exercise the option you can secure 100% financing.
A Master Lease Option is very similar to a Sandwich Lease Option. It can be used for any type of commercial property however for this discussion I am going to limit it to multi-family properties.
With a Master Lease Option you lease a property as a single tenant and then sublease it to occupant tenants. Think of a Master Lease Option as taking a property for a test drive.
The tenant, you, also known as the lessee, secures control of the property with the Master Lease Option. Then you will manage that property. Your goal is to increase the cash flow from the property and pocket the difference between what your master lease payments are and what you are collecting.
Why would a seller agree to a Master Lease Option? Who knows for sure? Everyone's motivation is different. A common reason is the owner is just tired of managing the property. They have what we refer to as 'tired owner" syndrome. Another common reason is someone or a group of people have inherited a property and have no idea how to manage it. The bottom line is that if the motivation is right, and the offer is compelling, some owners will agree to a Master Lease Option.
Let's see an example of how this might work. Suppose you find a twelve unit property for $950K that is generating cash flow at $1,000 a month. The owner is motivated and just plain tired of managing all those tenants and toilets.
So you get the property under control by using a Master Lease with an Option to purchase the property in the next three years for $950K. The offer is compelling because you offered the owner their current $1,000 per month cash flow as your lease payment and you are going to do all the work. Crazy you say? Are you going to manage the property for nothing? Not hardly, your research has shown you there is untapped "Gold" in this property.
Your research shows you that there are two "Value Plays" that should be implemented to increase revenue. First, rents are a little low and could be raised by $50 per month to be at the market level. Second, you also discovered that the units do not have washer and dryer hookups in them and there is space on the property that can be turned into an on-site laundry facility. You estimate that you can further increase your positive cash flow by $500 per month with the addition of an on-site laundry facility.
Over the course of the next twelve months you gradually raise all the rents by $50 a month and install the on-site laundry facility. The property should now be generating an additional 12 * $50 = $600 in rental income and $500 in laundry income. That's $1,100 a month you can pocket.
That $1,100 per month has not only put monthly cash in your pocket it has increased the value of the property. Next month I'll discuss how commercial property is valued.
Here are two commonly asked questions about Master Lease Options.
Q: What if there are repairs needed, I can't pay for them?
A: Just like any lease the owner would be responsible for the major repairs and the cost of repairs would come out of their portion of the cash flow.
Q: What if I can't or don't want to purchase the property within the 3 years?
A: No problem, just walk away. Your option gave you the right to purchase the property, not the obligation to purchase the property.
In summary, a Master Lease Option is a great tool to help you build your commercial real estate portfolio. It can be done with little or none of your own money. It can be done with little experience by using professional management companies. When you implement Value Plays, you create additional value in the property allowing you to finance with little or no money out of your pocket.
In fact, once you have had the Master Lease Option in place for 12 months, many banks will treat the financing of that property as a refinance rather than a new loan. Thus no need for a down payment and perhaps the possibility of taking cash out. What could be better than that?
Note: If the paperwork is drawn up properly you can sell your position as the Master Lease holder and retain the Option or sell the option and retain your position as the lessee with the Master Lease. There a lots of ways to make money in real estate.
To read more articles like this one visit our blog at www.REInvestingAssociation.com
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