257: The Advantage of Master Lease Agreements in Multifamily Investing (2023)

SHOW NOTES FOR EPISODE 257:THE ADVANTAGE OF MASTER LEASE AGREEMENTS IN MULTIFAMILY INVESTING

If you want to buy apartments but don’t have the money, credit or experience required, you need to listen to this podcast! Getting started in apartment investing can be intimidating to most new investors but it doesn’t have to be. In this podcast episode, best-selling author, educator, consultant and commercial real estate investor Peter Harris shares how a Master Lease Agreement can be just the right tool to help you acquire apartment buildings without previous experience, without qualifying for a loan and often, and without much money.

What You Will Learn

• What is a master lease agreement andhow can you use it to purchase apartment buildings?
• How a master lease works
• Advantages of master leases to both buyer and seller
• Two real life examples ofinvestors whoused master leases to acquire their first apartment buildings
• 5 reasons a seller would use a master lease agreement
• How to find a sellerwho would use a master lease agreement
• 6 critical things every apartment deal must have
• Protection”must haves” for those who want to use a master lease

About Our Guest

Peter Harris

Peter Harris is a return guest to the Old Dawg’s REI Network Podcast, having appeared on episode #101 entitled “From Converted Duplex to Working with Robert Kiy0saki and Donald Trump to Multifamily Mogul.” He began investing in real estate in the late 1990s. He has since acquired over 1,000 multifamily units, totaling over $50 million dollars. These purchases have spanned the United States, from California to New York, Ohio, Arizona, Texas and Oklahoma. His experience includes, but is not limited to, correcting management/operational issues, major renovations of commercial properties, rehabbing distressed commercial properties, re-positioning and re-branding commercial properties.

He currently, owns and operates a commercial real estate consulting firm specializing in multi-family investments based in San Francisco, CA. The Apartment Consultant. He is also Director of Education for a commercial real estate advisory firm based in Miami, FL, Commercial Property Advisors. Peter is also a commercial broker and has worked for Sperry Van Ness Commercial Real Estate and Coldwell Banker previously, focusing on buying and selling commercial real estate and income property in the San Francisco Bay Area.

Peter is the author of three best-selling books,Commercial Real Estate Investing for Dummies,Commercial Real Estate for Beginnersand3 Master Secrets of Real Estate Success, which he co-authored with Donald Trump. For 4 years, he has worked with Rich Dad’s Robert Kiyosaki Real Estate Investment Seminars, where he assisted clients and staff for their multi-day events. Peter holds a real estate broker’s license for the state of California and holds a BS Degree in Applied Physics from Cal-State University Northridge and holds several U.S. patents.

Definition of a Master Lease Agreement and Creative Financing

• A master lease is basically a way to buy commercial property with no banks, no credit requirements, no experience and with a lower down payment
  • A master lease is, to commercial real estate, what a lease option is to residential real estate – the same basic principal. However, Peter does not recommend putting in the “option” portionin a master lease agreement. Instead, he recommendsleveraging itas the perfect opportunity to make a lot of money
• In today’s show, we will focus primarily on master leasesas they apply to apartment owners and syndicators
• According to Peter, every investor should know how touse creative financing to acquire multifamily properties
• Definition of creative financing: nontraditional, uncommon or unconditional means of buying investment real estate to achieve a level of financial leverage not ordinarily possible.
• Investors need to be aeducated on creative financing to capitalize on opportunities and deals where traditional financing wouldn’t work or is not ideal.
• Topsituations fora master lease
  • Distressed seller
  • Distressed buyer
  • Distressed property

Master Lease Advantages

• Whenyou purchase a property through a master lease, lenders considerit as a real apartment ownership experience. It is called “equitable ownership”
• With equitable ownership you can:
  • Sell the property
  • Do a 1031 exchange
  • It’s just like owning the property

Actual Case Study of a Newbie’s First Purchase with a Master Lease Agreement

• Vicky – Single mom
• Tenacious, “no quit” personality
• Found a 64-unit “distressed” apartment building in Jacksonville, Texas. Here is a link toher actual property:Live Oaks Living
• Purchase price of the property: $1.9 million
• She couldn’t qualify for the $1.5 million dollar loan she needed to buy the property
• The seller was a hard money lender – he owned the property free and clear
• Seller couldn’t sell the property
  • Listed it on Loopnet.com but still couldn’t sell it
• Distressed property
  • 50-60% occupied
  • Below market rents
  • Had repair issues
  • Location was challenging to lenders because it was such a small town with a small population
• Vicki and Peter saw the “path of progress” in that town
  • New banks were opening for development coming to the area
  • The city was going through a transformation
  • 4 years laterthat assumption proved right
• They saw an opportunity in the property if they could successfully:
  • Cure the deferred maintenance (make the necessary repairs)
  • Get the property leased up and stabilized
• They saw the solution being:
  • To acquire the property with a master lease agreement
  • Get the property in position for long-term financing (they actually got a Fannie Mae loan after holding the property for less than 5 years)
  • Bring in new property management
  • Install marketing system to attract the “right tenants” they wanted
  • Cure the deferred maintenance
  • Increase the current low occupancy
  • Increase rents
  • Stabilize the property with a higher NOI (net operating income)
    • Producea favorable T-12 (the 12-month P&L statement that would show banks that the property was generating favorable numbers)
  • Find Vicki a “net worth partner” to help Vicki qualify for long-term financing. In other words, to qualify for the good loans, she needed to get a partner on her team – a sponsor and general partner whose net worth meets or exceeds the lending amount ($1.5 million) and who also has the “liquidity” to covermortgage payments for9 months. The sponsor would have to co-sign on the loan
    • Vicki was a jewelry sales person so she dealt with many higher net worth people
    • She was able to find a partner among her customers who would sponsor the deal
    • The sponsorwould have to cover the full down payment and capital improvement expenses
    • The incentive for her sponsor was:
      • 50/50 cash flow split
      • Would receivemonthly interest income payments via master lease agreement
      • When they obtain the loan, the sponsor would get 100% of their deposit back
• The Master Lease Agreement
  • 5-year agreement
  • 10% down
  • Vickiagreed to pay 100% of the mortgage, insurance, taxes and repairs
  • She had to hire and oversee the new property management
• The Loan
  • They were able to obtain a Fannie Mae loan
    • Non-recourse – which means there are no “personal guarantees”required to qualify for the loan and if she is ever sued, the person filing the case can’t go after her or the loan signor’s personal assets
    • 30-year amortization
    • 3.8 or 3.95% interest rate
• Two years later:
  • Cured maintenance ills
  • Got property lookinggood
  • Increased individual rentsby 30-50%
  • 90-94% occupancy (with waiting list on some of the smaller units)
  • With the sponsor, she was able to qualify for Fannie Mae financing
    • Got her down payment back (plus more) with closing
• The Results – Four Years Later
  • Vicki was able to pay-off the 5-year master lease agreement
  • Got 100% of her investor money (from her sponsor) back with the Fannie Mae loan
  • The property she purchased for $1.9 million was now worth $3.4 million
  • Cash flow today – $81,000 per year (she splits it with herself, her son and her partner/sponsor)
  • Vicki is now a millionaire
  • She is now looking for more properties to acquire

How a Master Lease Works

• A way to buycommercial property – apartments (small or large) – with no bank, no credit, low down payment and no experience
• Whatever terms of the deal you can establish with the seller is the agreement
• Can work with properties that have current mortgages in place or are owned “free and clear” by the owner
• Like a “lease option” used for residential properties but, instead of an option, they usethe word “agreement,” which is more acceptable to sellers
• You, in essence, buy the property from the seller with a small down payment
• You have all rights and privileges of ownership
• In closing, you get “equitable title,” not “legal title, “which means:
  • You are entitled to the property’s:
    • Cash flow
    • Tax benefits (except appreciation)
    • Futureprofits (the spread between the $1.9 million selling price and the $3.4 million value today)
      • As you increase NOI, the property value increases and, therefore, that increased value is yours!
  • Youare responsible forday-to-day management
• The more efficient you are, the more money you make

The Benefits of a Master Lease Agreement

• The benefits to the Seller:
  • Simplified (and fast) sales process
  • Seller receives regular monthly lease payments
  • Receives large down payment lump sum
  • Freedom from involvement in the day-to-day operations of the property
• Benefits to Buyer
  • A purchase involving no banks, credit checks, or appraisal
  • No experience required
  • Can get as creative as you want on the deal terms
  • Quick closing –low closing costs
  • No broker fees
  • Less financial risk
  • Receives all cash flow above the lease payment to the seller
  • All profits above the master lease price

5Reasons a Seller Would Want to do a Master Lease

1. If the seller is old, tired, ready to move on but doesn’t want to pay capital gains taxes, a master lease may help
2. Seller has kept rents low to keep high occupancy numbers because he wants to sell and get a good price
   1. The buyer can approach a seller in this situation and say “I will give you your price if you give me my terms.” And the buyer terms are the master lease terms
   2. Because the income is low, the lender will require a lot of money down for a mortgage loan
3. The seller wants to sellbut runs out of money to complete renovations and his partners want out and to recoup their original investment
4. Seller wants to sell but the property is in poor condition and no lender will touch the deal
5. Seller wants to sell but he hasn’t kept any present or past expense data and no banks will touch the property. Maybe they inherited property but just didn’t keep goodrecords – collect some rents in cash, no leases. Surprisingly there are more property owners than property investors

3 Things You Must do toLand a Master Lease Deal

1. Generate lots of leads
2. Develop rapport with sellers and ask the right questions to identify seller motivations
3. Structure the master lease agreement according to the seller’s motivations

A Real Life Example of How The Above 3 Factors Worked in a Deal

• Kevin sent out thousands of letters with the following criteria:
  • Apartment owners who
    • Own 5 to 50 units
    • Have owned the property for 7 years or more
    • Own more than one property
    • Are “out-of-state” owners
• Kevin received a call from an owner of a 24-unit apartment
  • He asked the right questions (Peter provided the script)
  • He developed a good rapport with the seller
  • They agreed to meet at the property
  • Several discoveries occurred during the visit (what Peter calls “seller motivations”)
    • Seller was finalizing a divorce
    • Didn’t want to sell outright because of legal and financial reasons
    • He eventually got court settlement giving him permission to sell the property
    • He wanted to rid himself of the responsibilities of owning the property and moving to another state and start a new chapter to his life
    • Two major motivations:
      1. Divorce
      2. Wants to start new chapter in his life
  • Commercial real estate is about people and creating win/win situations for everyone
    • Kevin used the two prime seller motivations to structure his master lease. He offered the seller the following:
      • 10% down
      • Took over mortgage payments
      • Manages the property
      • Will pay owner the balance at the end of year two
      • The seller said, “Yes!”
  • WhyKevin liked the deal:
    1. No bank financing
    2. Can leverage full control of the property
    3. Rents were $225 below market
       • A 72-unit right next door, identical building, getting $225 higher rents for comparable units
    4. Kevin’s exit strategy
       • Increase rents
       • Get it stabilized
       • Get cash-out re-fi and pull out Kevin’s original down payment plus the renovation costs
    5. Sellerwas motivated
  • Results one year later
    • Kevin increased NOI dramatically by:
      • Rent increases
      • Installed watermeters to bill back water costs to tenants
      • Able to increase rents but keepthe rents just a little lower than the competition next door
  • Results two years later
    • Able to get a Fannie Mae loan on the property
    • Favorable appraisal allowed him to pull out his original down payment and renovation money (which came from his parents) and pay them back
    • Kevin is doing syndications today

Peter’s “Default Structure” for Master Leases

• 10% down
• 5% interest-only payments for a few years

3 Key Master Lease Seller Concerns and How toAddress The Concerns

1. Is it a good deal?
   • Solutions:
     • The master lease document must be well-written and clearly show the “win/win” attributes of the deal
     • Youmust presenta business planwith an emphasis on your exit strategybecause that is ultimately what both parties want out of the deal
       • Note: You don’t share your how much you’re going to make with the seller (you have 2 business plans – one for the seller, one for investors) so to motivate them to do it themselves. The business plan you will share with the seller willread more like:
         • I will buy the property
         • Month one – Replace the windows
         • Month two – Evict these people
         • Month three – Fix the roof
2. What are the risks?
   • Solutions:
     • Give seller a monthly progress report with detailed data, pictures, video, etc.
     • Open an escrow account where the mortgage, taxes and insurance are escrowed, first and foremost, to insure regualr scheduled payments
3. Can they trust you?
   • Solutions:
     • Show your commitment level
     • Show you care about them as a person (this is a people business)
     • Persuade them that this is a good deal

6 Critical Things Every Apartment Deal Must Have

1. You must do a great upfront job of evaluating and analyzingthe property
2. You must understand the market and become a “market expert”
   • Know what expenses run “per unit” for your market
3. Must have an experienced and empowered team (this is a team business)
4. You must have a business plan with certain key benchmarks that will happen along the way to reaching your goal
5. Youmust be well-capitalized – have enough money in reserves because stuff just happens
   • May come from your investors
6. Exit strategy must be concise and conservative
   • Key tip to accomplish #6
     • Get your lender involved from day one. Tell him/her“I amacquiring a property with a master lease and I will want to fund it through a Fannie Mae loan in a few years and pull out my down payment. Where do I need to be NOI-wise, occupancy-wise, collections-wise, and sales comparison-wise (where does the market need to be?) for you to execute the exit strategy for me?”

Protection”Must Haves” for Those Who Want to Use a Master Lease

• Have an attorney create your master lease agreement. Never obtain a “generic” master lease
• Perform a property title search to make sure the title is clear and there are no liens or encumbrances or, if you know what they are, you have a plan to deal with those issues
• Obtain the services of agood escrow, title or holding company to retain copies of the original deeds and documents
• Record a “Memorandum of Record” against the property’s title. Keep it very “bland.” This gives the public constructive notice that you have an interest in the property and, more importantly, prevents the original owner from putting a loan on the property
• Get an appraisal for you and your investors to get a good idea of what the property value is today
• Hire a third party to make sure the mortgage and taxes are paid on time
• Include seller, property manager and buyer names are on the insurance policy

How to Reach Peter

• Website: Commercial Property Advisors (videos, books, etc.)
• YouTube Channel:https://www.youtube.com/channel/UCxO3rVNFN2gDHcSaPjR-YTA

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