What is Commercial Real Estate Master Lease? A Guide to this Complex Form of Leasing Property

If you’re just starting to explore commercial real estate leasing and property investing, you’ve probably heard the term “master lease” mentioned a few times. While it sounds like some sort of exotic bird, the master lease is actually a type of leasing agreement that businesses use quite often. However, while this type of lease structure is simple in theory, its many loopholes make it much more complicated in practice. This article explains what a master lease is, how it works, and why you may want to consider using one if you are planning on investing in commercial real estate.

What is a Master Lease?

A master lease is a long-term leasing agreement in which one party – the owner – leases out a piece of commercial real estate, and another party – the lessee – rents the property for a set period of time. Typically, the owner retains the rights to the land, while the lessee rents out the building on the property. In a master lease, there may be a third party – an affiliate – that also leases out the property (the master lease). For example, if a property owner has a shopping center with 10 stores and wants to ensure that the stores have long-term tenants, he may sign a master lease agreement with each store to guarantee that each store stays put for a minimum amount of time. In the master lease agreement, the property owner may include clauses that obligate the affiliates to abide by the same rules as the lessees under the main lease agreement. This way, the property owner can ensure that the affiliates follow the rules and that the shopping center maintains a high level of customer service.

How Does a Master Lease Work?

When a business signs a master lease agreement with a property owner, the business agrees to lease out a piece of commercial real estate for a set period of time. Under this master lease, the business may or may not have an option to renew the lease (in which case, the business and the property owner would negotiate a new lease rate). Under the master lease, the business may also agree to sublease the same property to other businesses. This can be especially useful in cases where the businesses on the property are related (e.g. two franchise outlets in close proximity). In short, a master lease is a long-term leasing agreement that guarantees one party – the lessee – a set amount of space to operate a business, while the other party – the owner – receives monthly payments.

Why Would You Use a Master Lease?

There is no set rule as to why businesses sign master lease agreements. In some cases, the owner may have wanted to expand her real estate portfolio for years but lacked the capital to make the investment. If the owner can sign a long-term lease with a strong tenant, she may be able to get the financing she needs. In other cases, the owner may not have wanted to deal with the hassle of finding tenants and signing contracts for each of the spaces. A master lease offers the owner the chance to lease out all of the spaces at the same time, sparing him from the burden of negotiating with potential tenants.

Drawbacks of a Master Lease

The master lease is not perfect, and like all commercial real estate agreements, it comes with its share of risks. One of the problems with the master lease is that it can be difficult to find a tenant that is willing to sign a long-term lease. In an interesting piece, Business Insider points out that businesses are more likely to sign a short-term lease than a long-term one. This may be due to the fact that many businesses are short-term. Rents work on a per square foot rate, and a short-term lease offers a low rate. A long-term lease, on the other hand, equates to a higher cost per square foot.

Should You Use a Commercial Real Estate Master Lease?

Before you sign a master lease, you should do a thorough analysis of the benefits and drawbacks of this type of lease. Keep in mind that you can make the most out of a commercial real estate master lease if you choose the right property for the job. Furthermore, you should make sure that the property owner uses a reputable real estate lawyer to draft the master lease. A poorly drafted document can leave you vulnerable to unforeseen issues. If you still think that the commercial real estate master lease is right for you, go ahead and sign the contract. When you are done, remember to keep a close eye on the lease rates. If things don’t go according to plan and the owner’s rent payments start to fall behind, you may want to think about breaking the lease.

Final Words: Is the Commercial Real Estate Master Lease Right for You?

The commercial real estate master lease is a complex leasing agreement that can benefit both business owners and property owners. However, before you sign a master lease, you should carefully analyze the contract. You don’t want to end up signing a long-term lease under unfavorable terms. If you feel that a master lease is the best option for your business, go ahead and sign the contract. And make sure to keep an eye on the lease rates. If the rent payments start to fall behind, you may want to think about breaking the lease and seeking new tenants.