What is a Master Lease Agreement?
Master leases provides the investor with “equitable title.” In other words, you get all the rights typically associated with ownership, including the right to rent it out, keep the cash flow, and reap any tax benefits.
You don’t actually own the property, but the agreement typically gives you the right to acquire the property outright under specific terms at a defined point in the future. In exchange, you make monthly lease payments to the owner, who in turn uses those payments to pay their mortgage.
A seller typically needs to be pretty motivated to accept a master lease agreement. Also, in situations where the seller is having major issues with a property, a master lease agreement can sometimes be an attractive option. Similar to seller financing, master lease agreements can be attractive to sellers who facing personal issues, or deferring the tax consequences of a sale
Master leases agreements can be useful where you are acquiring a distressed property whose cash flow wouldn’t meet the banks lending criteria. This option is also useful for value-add strategies because the final acquisition price is locked in, so the term of the lease can be used to increase the value of the property. Essentially providing you with the opportunity to create a stable rent roll and create enough equity to conclude the transaction with 100% bank financing.
Like any investment, master lease agreements involves a level of risk that should be appropriately mitigated before finalizing any agreements. So it makes sense for an individual or real estate investor to carefully consider the viability of a borrower before providing seller financing.
In addition to considering a potential buyer’s credit history, income, and payment history, a seller should also obtain an accurate valuation of the property and understand what potential exists for appreciation or depreciation in value.
Additionally, it’s wise to give some consideration to the loan-to-value ratio (LTV). Generally, traditional lenders set limits on how much of the total value of a property they’re willing to lend as a means to limit their risk. They base this number on things like the borrower’s credit score and the type of property being purchased. The lower a borrower’s credit score, the less a bank may be willing to lend.
In a master lease agreement, the seller may also want to consider these factors when determining an appropriate down payment and interest rate from the borrower. A borrower who is willing to offer a higher down payment is less likely to walk away from a loan. An appropriate down payment also provides the seller with enough money on hand to cover costs associated with the unlikely event a foreclosure is necessary.
A buyer who is considering seller financing will also want to adequately protect their interests in the transaction by conducting their own due diligence on the property they’re considering. They should perform a title search to ensure the home is fully owned by the seller and there are no additional liens on the property. They may want to order a home inspection, and they should have a strong understanding of the surrounding market to ensure the home is priced appropriately.
Both parties may want to utilize an attorney to ensure all documents are legal and binding. Preferably one with experience in this particular area.
When an underlying mortgage is involved, provision should be made to be certain that the seller is making 100% of their mortgage payments. This may involve setting us a third party attorney to administrate the payments.