What is a Master Lease and How Can Investors Use It to Scale?
Property management is a low-margin and labor-intensive business because it’s difficult to maintain a property and keep tenants happy. It’s why many real estate investors outsource property management so they can focus on scaling acquisitions.
In this article, we will discuss a master lease, how it differs from traditional property management, the benefits of a master lease, and more.
What is a Master Lease?
A master lease is an agreement where a property manager (PM) leases a building from an owner for a negotiated price and then subleases the building to other tenants. This is a strategy used with other real estate assets, such as Airbnb arbitrage, but it can also be used in the commercial sector and elsewhere.
Generally, master leases last for one year, but it varies based on the deal made.
Types of Master Leases
There are generally two types of master leases:
Fixed Master Lease – the lessee agrees to make monthly payments to the owner regardless of profits or tenancy.
Performance Master Lease – the lessee agrees to pay a percentage of profit only when rents are received.
A combination of both is called a hybrid master lease and are preferred by many property owners. In a hybrid master lease, there’s a guaranteed monthly payment from the PM, but owners get additional income if the total rents exceed a certain amount. Basically, you can make more profit if the PM can acquire more tenants at higher rent rates.
Master Lease Terms
Typically, a master lease contract lasts for a year. Depending on the market conditions and your property’s current state, the PM may require free rent or concessions to allocate enough time to improve the property and lease-up.
The costs for maintaining the common area need to be negotiated. Typically, the maintenance costs for amenities that the residents regularly use, such as the pool and gym, are covered in the master lease. The owner should cover everything else in the common area not used daily.
Pros of a Master Lease
A master lease can help save on payroll, marketing, maintenance, and more costs. Overall, you could expect to save 12-15% of your gross income.
Generally, in master leases, repair and maintenance are covered by the PM, but the costs for the common area vary case by case. Usually, the owner pays for the common area, but the PM might cover costs for maintaining the amenities commonly used by residents, such as the clubhouse, gym, roof terrace, pool, etc.
A master lease guarantees you a minimum rental income, which is great for financing. For example, if you own a property in bad shape and has a lot of vacancies, you could turn around the rent roll quickly by doing a master lease. Instead of taking months to renovate the units and lease out, you can simply refinance with the master lease agreement.
Motivated Property Managers
In a master lease, the PM is also more motivated to lease out your units because they could lose money if the property has vacancies. Traditional property management pays a PM based on a percentage (usually 7-12% percent) of the gross income.
In master leases, the agreement terms are different, which means the PM may have more control over their income, for better or worse.
Lastly, master leases require little management from you, which equals more time to focus on other responsibilities.
Cons of Master Lease
Although expenses can be reduced significantly, the property’s net operating income (NOI) could be lower because the total gross rent is discounted at about 20-25%. For example, if the market rent is about $3,000/mo, then the master lease would be about $2,400/mo. NOI loss is more common in a hot rental markets like Los Angeles and New York when the market rent is rising faster than expected.
A 20-25% discount sounds like a lot, but it’s not as significant if you account for general vacancy, costs in payroll, marketing, and maintenance. Even in a hot market, vacancy can still be around 3-5%. During the pandemic, the vacancy rate in San Francisco reached as high as 10%, so a master lease is beneficial to the owners when the market is not doing well.
Many PM companies that do master leases offer short-term rentals and charge a large premium. Properties that have daily turnovers will have more wear and tear. Make sure to include a clause in your contract to address the conditions of the units at the end of the master lease to protect your properties.
Bankruptcy is something that you should also consider. Some PM companies were run out of business during the pandemic because they had aggressive master leases. Make sure the PM company you hire is reliable and can pay their commitments.
Notable Companies Using Master Leases
Master leases are low margin, like traditional property management, and risky business for property management companies, which is why most property management companies have not adopted this business model. Nevertheless, there are some notable startups doing master leases actively to expand their portfolios, such as Tripalink, Bungalow, Sonder, and more.
These companies usually take over your units in their current condition and sublease them out to other tenants at a higher price by decorating and furnishing the apartment. Some do short-term leases like hotels and Airbnb.
If you’re tired of managing your properties, contact these companies and give them a try! You might like it more than you expect!