How to Use a Master Lease to Acquire Commercial Real Estate With No Money Down
The vast majority of commercial real estate deals are “conventional” with regard to financing, meaning they are financed with a commercial lender requiring 20% – 30% down. But it’s important to have other, perhaps more creative, financing techniques at your disposal because they can get you into a deal when traditional methods fail.
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One of those techniques is the master lease.
While the details of a master lease can vary widely, here it is in a nutshell using a case study scenario.
Let’s say you’re looking at an apartment building and have determined it’s worth $1.5M based on actual financials. The building has problems: there is quite a bit deferred maintenance, and as a result, the owner has about 30% of the units empty and he hasn’t raised rents in the last 5 years. The building needs some TLC and better management. You think that if you sink about $120,000 into the building and replace the property manager, the building would be worth $2.5M.
Unfortunately, the seller is dead-set on $1.7M, and nothing less. And he’s certainly not going to give you a $120,000 repair credit.
Sharpening Your Pencil
You could walk from the deal, or you could propose some creative financing to see if you can get something to work before you move on.
You propose to the seller that you lease the building from him with an option to buy. Every month you will make a lease payment so that the seller can pay his fixed expenses (like mortgage, real estate taxes, and insurance) and put a little extra in his pocket.
In return, he gets his asking price of $1.7M, and he doesn’t have to worry about having to manage his sinking ship, uhh, I mean apartment building. He still gets all of the tax benefits. Perhaps you pay him something for the option to buy, even though if he doesn’t ask for it, don’t volunteer the idea.
You, in turn, will invest capital in HIS building to make it better, and if you don’t exercise your option to buy, he still owns the building and it’s likely to be in better shape than it was before and he can sell it again.
Even though you don’t OWN the building, you CONTROL it. You are now working for the upside in both cash flow and appreciation. If you make the necessary renovations, reduce the vacancies and raise rents, you’re not only making a monthly income, but you’re also raising the value of the building.
Cashing In With No or Little Cash Down
If you play your cards right, then in 1-2 years the building will be worth $2.5M. At that point, you could actually market the property, get a buyer at $2.5M and do a double close, pocketing a gross profit of $800K.
Or you could hold it yourself. Assuming the building appraised for $2.5M with 20% down, the loan balance would be $2M. That would be enough to cash out the seller for $1.7M and put $300K into your pocket and you now own the building!
If you like the lease option idea, you can read more about it in Brandon’s ebook How We Bought a 24-Unit Apartment Building for (Almost) No Money Down because that’s how he bought that building with some additional twists and turns.
The nice thing about a master lease is that it allows you to get into a deal with no or little cash (except the capital you might need to renovate), and it allows you to benefit from the upside you create through better management.
While most deals get done with more “conventional” financing, it’s great to have creative techniques like the lease option in your investing toolbox so you can get deals done when a more traditional approach won’t work.
Have you ever used a creative real estate technique successfully?
Let us know your experiences in the comments section below!