When new development is occurring in a market and developers are anxious to sell when the construction is complete, use of a master lease may facilitate a sale before the lease-up period is ended. A master lease is a form of seller guarantee that has several specific goals:
• It enables the seller to negotiate a price that reflects a stabilized occupancy and the long-term potential of the property.
• It assures the purchaser of a guaranteed level of income over an initial period and so assures for payment of debt service and equity dividends.
• When an appraisal is a necessary prerequisite for the purchase, the master lease enables an appraiser to value the property without regard to the initial vacancy rate (although certain adjustments may be required).
When a seller agrees to become a master tenant (and so be responsible for the agreed rental regardless of the actual occupancy level), the seller usually insists on having the management contract for the property for the duration of the master lease to assure an aggressive leasing effort. This also enables the seller to earn leasing commissions and usually is agreeable to the purchaser, which also is interested in achieving full occupancy as soon as possible.
The Terms That Protect Buyer And Seller
The essential purpose of a master lease is to assure the buyer that it will receive a specific amount of cash flow throughout the master lease term. The obligation on the seller can be structured in one of several ways. The seller may guarantee that a certain occupancy level will be maintained or that gross rents will not decline below a specified amount. The lease should contain protective provisions for the buyer; for example, the seller (as manager) should not be able to reduce rents below market merely to achieve a higher occupancy rate. Similarly, the seller-manager should not be able to offer additional and costly amenities in order to increase gross rental revenue. The term of the master lease usually will approximate the estimated time for the property to attain stabilized occupancy. Finally, the obligation of the seller should be secured through an escrow account, letter of credit or other form of guarantee.
Always contact a qualified real estate attorney and your real estate broker to create a master lease agreement form that is appropriate for the state where the property is located.