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.
Master leases can be structured in many ways, but their purpose is to
provide the income stream necessary to support project financing. Some common
the master tenant leases the entire project and subleases space to
- 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.
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
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
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.
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.