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Tenants-In-Common and Master Leases
How and by whom a property is managed in addition to its economics are the "nuts and bolts" of any real estate investment. If the goal is to minimize management for income producing real estate there are three basic approaches, own a triple net lease property outright (the tenant does the management and pays a fixed monthly amount), invest in a fractional interest Tenants in Common that uses a Property Management Company or invest in a Tenants in Common that uses a Master Lease structure.
For this article we are going to focus on the Master Lease structure used with Tenants in Common investments. With a Master Lease the Lessee leases the entire property from the TIC owners thus relieving the owner of management responsibility and providing a fixed level of income.
Investing in a Master Leased TIC properties has both advantages and disadvantages for the investor.
Generally, the benefits of a Master Lease include:
Steady income regardless of market fluctuations. The Master Lessee is obligated to pay the agreed upon lease rate to the Tenants in Common owners regardless of market fluctuations. This is the same as a triple net lease property but unlike using a Management Company where income will reflect the market over time.
Little to No Ownership Management Required. With a Master Lease the owners are contracting out the management of their investment. This is the same as using a Management Company or owning a triple net lease property.
The Master Lessee typically pays all expenses including maintenance and repair on the property. Depending on how the master lease is written the Tenants in Common owners could bear some or all responsibility for any necessary capital expenditures (e.g., new HVAC, roof, etc). It is important for the Tenants in Common owner to fully understand all terms in the master lease before investing.
Disadvantages of a Master Lease can include:
Potential Loss of "upside." Master Leased properties pay a flat percentage of cash invested with possible fixed annual increases or annual bonuses as a percentage of increased income. All income above this fixed income is kept by the Master Lessee thus depriving the owners of potential increases in income they would realize if they were using a Management Company.
Risk of Capital Expenditures and Maintenance. Because the Master Lessee keeps everything not paid out in expenses, capital improvements or fixed payments to the investor there is the risk that the property will not be properly maintained or that capital improvements will not be performed in a timely manner.
Risk of Loss of Real Income. The fixed income that is produced by Master Leases seldom adequately adjusts for inflation over time. For a ten year investment paying a flat 6% to 7% the loss in buying power can be significant. One of the major benefits to owning real estate is that it historically has adjusted for this loss in value of the dollar.
It is important that the investor identify what they are gaining by giving up such important aspects of an investment.
Risk of Undercapitalized Master Lessee. Frequently the Master Lessee is set up in separate LLC by the Tennant in Common Sponsors. This protects the sponsor if something goes wrong with the property but can leave the investor holding the bag.
Investors should carefully look at how the Master Lessee is capitalized both in amount and in quality. Is it cash, a letter of credit or simply an IOU from the sponsor that could turn out to be worthless?
Some sponsors provide “guarantees” or “pledge” their balance sheet to assure the investor of even cash flow. These “guarantees” or “pledges” need to be carefully looked at to make sure there is adequate financial strength to cover the investor if more than just their property goes south.
Master Lease or not, an investor needs to evaluate the risk of an investment on the stand alone qualities of the property being considered. This would include examining the existing leases, the quality of the tenants and the demographics of the property, among other things.
It is important that the investor understand that their ultimate security or lack thereof comes from the quality of the underlying property they are investing in and not rely solely on who holds the Master Lease.
At the end of the day if something goes wrong the investor has a deeded interest in a piece of real estate. For this reason the investor needs to make sure that they understand the risk associated with the real estate they are thinking of investing in and that it is appropriate for their needs.
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