Master Lease Option Agreement Real Estate Method Explained
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- čas přidán 22. 08. 2024
- In today's video we will be covering the master lease option agreement by considering a real property in Toronto. In our example, we will project cash flows assuming tenant improvements and potential tax deductions.
This deal structure is a more exotic way to invest in a property without bringing too much equity to the table. As always please conduct your own due diligence before making any decisions.
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From what I've understood by other investors, you would not offer a lease price of what they currently earn, but rather to cover mortgage payments + a fee. And why they would accept this is because they are highly motivated to get rid of the property and will have the property taken off their hands. I also understood it as the seller during this period will use part of the money you pay them to pay mortgage costs, thus decreasing the mortgage on the property. During the time of the lease, all income generated by the property goes to the master leaser, as well as all of the management responsibility.
Once you then take the option to buy the property, the seller will have less of a mortgage which will mean more profit for them, while you have the benefit of the (hopefully) lower than market price. I don't think I would want a master lease contract if it meant I had to pay the full current rent income to the seller. Not sure if I got everything right but that's the way I've understood it.
By income I mean cashflow occurs,sorry if some of my terminology is off, English isn't my first language.
Thanks for the comment Marcus, let me try to clarify. The master lease agreement can be used in many scenarios, you are referring to the vulture agreements which require a high risk tolerance because the property is either in a bad shape or attracts bad tenants. However, that is not the only case where a master lease can be used. Even with decent to good properties, if you can find a willing owner who would take the guaranteed income rather than risk facing vacancy and you as the investor feel you can increase cash flows, the agreement would still work. So really there is no set scenario where the lease would work as long as each party can extract some value. It just needs to be agreed upon by both parties.
With regards to the mortgage payments. What tends to happen is the lessor accept a payment which at a minimum covers their mortgage costs, anything above that is just gravy. If you have a $1,000,000 mortgage and over 2 years it goes down to $800,000 (paid by the lessee's installments) the lessor benefits, the buyer would receive nothing as their option doesnt change. If they agreed to buy it for $1,000,000, that 200k capital gain is going all to the lessor not the lessee. It wouldn't be profitable to offer a floating option because the lessee would benefit more.
FinanceKid so with what you described , what would be the best route in suggesting a master lease to a Highly motivated seller? I currently have a opp deal for 7M (26 units rent 2225 ea unit) 3/2b/bth) id like to offer the master lease option so I can have the deal and pay to own it on a 5 year contract. The 26 units are all individual 2 story homes/ condos and would be a great asset due to location, they can even be individually sold if desired. Too good of a deal to pass up but I’m not sure how to approach with the master lease option. In a way we both win
@@yaasupreme8080 what happened with this deal?
@@yaasupreme8080I wonder what you ended up doing
great video, thanks for putting it together! I am wondering about the expenses though. If buyer takes on the expenses and maintains the owner's current payout, buyer is at a negative unless they force appreciation - and very quickly. Adding the new loan payments plus building expenses could result in a negative cash flow if not structure well. The options are to increase in rents or other appreciation so it is high enough to make this work within the first year or the owner agrees to go down on their monthly lease payment. Its a good long term play but the buyer has to be very careful with selecting a property that fits this structure.
If you did $110,000 in improvements, your returns wouldn’t be as they are in the video because you would have debt service on the $110,000 assuming you didn’t have the money in your savings account. If you did, your cash on cash return wouldn’t be good. If the property went way up in value over the option term, then you would have made a good deal, but that is a big risk. I think master lease options are a good alternative, but not so much in your example. I realize it is simplified, but some may read it and make a bad decision if they only understand it from the simplistic view point.
Very practical & insightful. Important lessons for current market real estate transactions.
No interest payments to the bank? No tax payments? Good example but missing some key lines for cash flow statement
Naturally, it's a simplified example to teach the core concepts. Thanks for watching.
This is great if the apartment is already leased out, but what if the apartment building is vacant?
You produced a number out of thin air.
Where does the 110,000 dollars for renovations come from, especially if you are broke?
It all depends on the situation the investor is in, I made that number up just for the sake of the example. This is an arbitrage opportunity that you can exploit and if the property needs $0 in renovations to increase the monthly rent spread then that's great! Now consider an example where the owner is facing a liquidity crisis and is unable to complete the necessary rennovations to relist some of his units on the market. You could take advantage and set up an agreement below market, provide that necessary capital to complete the rennovations and relist the units at their true market value. So it all depends on the situation.
In this example, I wanted to also introduce investment loans to talk about their tax advantages so that's why I assumed some rennovations could be made. Thanks for watching!
You said we would offer to make pay him what he’s currently making now, $9000 per month. What he’s making now is gross and he takes the repairs out of that. If I am now going to take responsibility of making repairs wouldn’t I agree to pay him what he’s netting and keep that amount to spend on repairs for myself? Otherwise I’m coming out of pocket with repairs for a $2.3 million property and if I can afford the down payment I may not be able to afford the repairs.
What would the potential risks or downsides be for the property owner in this agreement?
What if the seller dies? What happens with the master lease then?
great video i just have a question if the tenants are paying $3k a month and are on a lease or any other contractual agreement with the main owner of the property would you not have to wait for the lease or agreement to expire before you can raise the price an additional $500. also are there laws against spiking the rent at a %16.66 increase in such a short time? thanks in advance brother!
Thank you.
Is that 5 year master lease option the most you can extend it or have you been able to get an 8, 10 or longer option?
Thank you! Great 'Canadian' video! Now pls help me understand what are the scenarios in which the seller would agree to a Master Lease Option? What is the benefit to him/her?
No need for a video. The best way to describe it is by understanding portfolio theory and the balance between risk and short-term certainty. Normally, as investors age, they change their portfolios to focus on increasing short-term certainty in anticipation of their funding needs when they retire. This is why in the stock market, young people hold more stocks than bonds whereas old people hold more bonds than stocks. For real estate holdings, the master lease increases certainty for the owner. In circumstances where you want to reduce the amount of time you invest in tending to tenants and maintaining these properties as you get older, leasing the property and getting guaranteed payments increases your cash flow certainty and reduces your workload. In addition, if you expect to start selling off your portfolio (hopefully in a tax efficient way) in order to buy that cottage or new car during retirement, putting in the exercise option into the master lease provides clarity on what you expect to receive for the property.
Talking about taxes, before retirement you usually have your main salary plus real estate income. Now if you need money and choose to sell now, the tax you pay on your salary plus capital gains is more than if you retire and then trigger the sale through the option. Again there are so many factors but say for example you are 60 and expect to retire at 65. You want to sell one of your properties to finance your retirement lifestyle. Selling now puts you in a higher tax bracket than selling when you have retired from your job. Engaging in a 5-year master lease with an exercise price slightly above today's market value saves taxes now and ensures that you know how much money you will have when the lessee chooses to buy the property.
There are of course many variables and for younger property owners this option is not the most prudent in capturing gains. To summarize:
- Increases cash flow certainty
- Provides clarity on what you expect to sell for
- Reduces your workload and defers your capital gains tax to a period where you earn less income
Thanks for watching. Good luck!
Thank you so much.
How do you structure the transaction if you want to exercise the option and buy the property but you still don't have the 20% down payment cash?
The idea is that raising the rents improve the NOY and thereby vastly improve the value of the property and now what you owe is a percentage of the value. Once you cash him out maybe he would do a second for the down payment amount. So many questions, nobody’s answering us
How do you find and contact the owner? That's the issue I'm running into and awesome video
Thanks for watching, that is a great question but it really depends on the situation. A simple example would be if the property has been previously listed, you could contact the listing agent and ask if it would be appropriate to reach out to the buyer. If the units were listed as available for rent, then most likely the owner's contact info is already available. If not, just walking in and asking one of the tenants would be simple although you would need to practice the "ask" if it was your first time. The challenge isn't reaching out, its finding the right property especially someone willing to agree to a master lease. Best of luck!
How do you use the Master Lease Option Agreement, if you want to keep the property?
You just lease it yourself to buy. Or do an owner finance agreement.
expenses are much more than mortgage. Never use that formula or you will be hurting.
So...you don't own investment property...are self-admittedly unfamiliar with this subject...and put out a video for folks that don't know what they are doing to watch. Seriously? Is getting attention on your You Tube channel that important.
He highlights the concept but in reality there are too many pitfalls in his case study to take such a huge risk.
Would lease option/MLO work with bank owned properties?
No, you are unable to in almost all cases. With bank-owned properties, the company usually acquired the property through foreclosure after a failed mortgage. For them, getting the property off the books and trying to recoup the highest value to cover their loss is the main goal. They are not asset management companies that enter into MLO agreements to generate long-term returns. They want to offload the asset to reduce risk and cover their loss.
To deal with this scenario, people usually partner with other investors whereby the investor buys the property and leases it to you. Problem is that these agreements usually are not as profitable because the investor who put up the money to buy the property is looking for a higher return due to higher risk. Remeber this is a property that was foreclosed on, so the fundamentals are not that strong in most cases which means that the returns to attract such an investor need to be high. Of course you could buy it yourself but that would not be a MLO but rather vulture investing! Best of luck, thanks for watching.
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