A few weeks back, we discussed creative financing techniques. In it, I mentioned the Master Lease Agreement (MLA). I realized that this interesting way to acquire property demands its own post.
Let’s start by saying that this is a creative financing technique. These are typically employed only when either the buyer or the seller has some level of distress. For instance, the buyer can’t get a conventional loan for some reason or the seller is not making his mortgage payments and the bank is threatening to foreclose. If there is no distress, both will choose the easy route of a traditional sale. Sellers usually prefer to sell outright and get a big lump of cash so don’t offer an MLA. Buyers would rather own the building outright and permanently so don’t ask for an MLA. It’s only when these can’t be done that the MLA gets thrown into the mix.
What is an MLA?
The MLA is a way for the owner to maintain ownership, continue to pay his mortgage, and give up the day-to-day operations of the property. In return, the owner gives the authority to set and collect rent, make improvements, and pay bills. One exception is that the owner often maintains responsibility for property tax and hazard insurance so he knows it is getting paid. He then bills these to the buyer (now, lessee). The lessee pays the owner either a fixed amount or a percentage of the profits plus the tax and insurance bill. Any extra that the lessee makes he gets to keep. The owner now has a steady source of income. The lessee is now a single tenant of the property with the right to sub-lease.
The MLA often ends with an option to purchase. At a pre-specified time, perhaps 2-5 years, the lessee is given the option to purchase the property or walk away. The price has also been pre-specified when the agreement was signed. This option is usually purchased with a fee paid up front to the owner. When the option is combined with an MLA, it’s called a Master Lease Option.
The MLA needs to be drafted by an experienced attorney. These are high-dollar agreements and neither party wants to be the loser.
Benefits of an MLA
To the Seller:
- His distressed property is now making money
- Gets monthly payments rather than a lump sum, which is subject to tax
- Guaranteed (pretty much) income
- Moves a step forward with selling
To the Buyer:
- Sometimes doesn’t need any down payment
- Doesn’t have to work with a bank (quicker, no closing costs, no appraisal)
- Option to buy is very nice. If the value has increased, he has a great deal. If value drops, he can walk away
- Lots of risk with a non-typical agreement
- A sale doesn’t happen right away, and is not guaranteed
- Creates a partnership, of sorts. Both parties better work well together
- Upfront cost to attorney is not recouped
- If lessee fails to execute rehab plan, the place can languish, owner takes back a dilapidated property, and lessee has lost a bunch of money as well
- There will probably be re-negotiation during the option period
There are lots of risks with the MLA. It’s not for most deals. The property better be really great for the buyer/lessee to go forward. Similarly, there must not be any better offers on the table for the seller to do an MLA. Keep it in your toolbox for that great property on which you just can’t get typical financing.