Financing Focus

Master Plans

Use these lease structures to build a property's revenue stream.

Financing a commercial real estate project based on its rental stream presents many challenges for property owners. These challenges intensify when deficiencies arise from vacant space, scheduled lease expirations, tenant concessions such as free rent, or other lease attributes that are scrutinized in the lender's underwriting process.

Lenders may seek to have perceived rental deficiencies covered by a master lease in which all or some portion of a commercial real estate project is leased by a creditworthy master tenant providing an additional or backup rental stream. The master tenant typically is a landlord's principal or affiliate, and the master lease is assigned to the lender as collateral.

Lease Structure

Master leases can be structured in many ways, but their purpose is to provide the income stream necessary to support project financing. Some common structures include:

  • the master tenant leases the entire project and subleases space to occupying tenants;
  • the master tenant leases specific vacant space only, and the master lease terminates when space later is leased to occupying tenants;
  • the master lease covers only the vacant space in the project from time to time, floating to coincide with actual vacant space;
  • the master lease applies to specific space covered by a lease with an upcoming expiration and takes effect only if that lease is not renewed or the space re-leased; and
  • the master lease only covers space during a rent abatement period when the occupying tenant pays no rent.

If the master lease was given as credit enhancement for the loan in the event of the owner's default, it performs the same function as a guaranty. The lender looks to the master tenant as a secondary source of recovery after it has foreclosed on the property. At that point, the new landlord - the lender or other successful bidder at foreclosure - would seek to collect rent payments due under the master lease.

Re-characterizing Leases

Under certain circumstances, courts will not honor the form in which a transaction has been documented if the parties' true intent was a different type of transaction with different legal results. In these cases, the decisions rely heavily on the individual facts, and the court's analysis varies from state to state.

Under court scrutiny, a master lease may be treated as a disguised loan guaranty, which has significant implications to both the master tenant and the lender. Questions courts must address include:

  • Was the master lease a condition to the lender making the loan?
  • Is the master tenant a party that might otherwise have given a guaranty?
  • Does the rent called for under the master lease produce just the amount of property income necessary to meet the lender's underwriting standards?
  • Did the master tenant ever occupy the property?
  • Did the lender treat space leases as direct leases to the borrower rather than as subleases?

If the answer to some of these questions is yes, the master lease may be treated as a guaranty. Alternatively, if these circumstances do not apply and there is an independent business purpose for the master lease on market terms, the master lease should be treated as a true lease.

When a master lease is viewed as a true lease, the lender's recourse to the master tenant is analyzed in the same way as its recourse to any project tenant. The lender's collateral includes an assignment of all project leases and rents. In many states, following the borrower's default, the lender is entitled to appoint a receiver to run the project and collect rents until the lender can hold its foreclosure sale. Prior to foreclosure, the receiver may enforce the master lease; after foreclosure, the successful foreclosure bidder becomes the new landlord under the master lease, entitled to enforce its terms. If the master tenant does not pay its rent upon demand by the receiver or new landlord, it will be in default.

In many states, the remedy for landlords to collect rent from tenants in default is to terminate the lease and sue the tenant for delinquent rent and future rent through the end of the lease term. Each state has its own rules for determining what the landlord may collect for delinquent and future rent and the duty of a landlord to mitigate its damages by seeking a replacement tenant.

Assuming the master tenant is in default under the master lease, a lawsuit against the master tenant seeking to collect these amounts generally could be commenced any time after a receiver is appointed or a foreclosure sale is held.

Disguised Guaranties

If a court determines the master lease should be re-characterized as a guaranty, it will rewrite the master lease to follow what it believes was the parties' true intent. The first question the court must face is determining the amounts guarantied. Assuming the master lease was signed to provide sufficient income to service the loan, a natural conclusion would be that the master lease constitutes a guaranty of debt service up to the amount of rent called for under the master lease. The guaranty also might cover property tax and insurance payments and common area maintenance charges.

The lender would be entitled to demand that the master tenant pay the guarantied amounts and if not, the lender would be entitled to bring a lawsuit enforcing the guaranty. Guarantors generally have various defenses to guaranties, known as suretyship defenses. While most guaranty documents provide waivers of these defenses, a master lease would not normally contain these waivers. The master tenant may be able to raise suretyship defenses, which generally include the right to require the lender to first exhaust the lender's remedies against its collateral and the borrower before seeking recovery against the master tenant.

Some lenders attempt to address this problem by including suretyship waivers in master lease documents. This should assist in enforcing a master lease if it is re-characterized as a disguised guaranty. However, this language in a master lease would clearly show that the parties were cognizant of this risk and may be used as evidence that the parties intended a guaranty rather than a true lease.

Effective Uses

A master lease can be a useful tool for commercial property owners to enhance financing opportunities. Whether this legal obligation should be structured as a master lease, a guaranty of cash flow, or debt service needs to be considered carefully by borrowers and lenders under the advice of legal counsel. In most cases there is a structure that meets the needs of both parties that can be implemented while minimizing the risk of later re-characterization by a court.

Douglas P. Snyder

Douglas P. Snyder, JD, is a partner at Cox Castle & Nicholson LLP in Los Angeles. Contact him at (310) 277-4222 or


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