A Technique to Buy Apartments and Other Commercial Properties
If you’re looking for a way to get starting investing in commercial properties then you’ll want to know how to use the Master Lease Option technique as a way to acquire a property without having to use much of your investing capital.
To use the Master Lease Option technique you’ll need to take three steps.
Step one is the same as buying a nice home with nothing down: find a motivated seller who has a specific need or problem for you to solve and who will be open to your creative offer.
I heard about Carrie from a real estate agent named Tim with whom I had an established relationship. Tim was out fishing for listings when he found a 24-unit apartment building, owned by a woman named Carrie, who needed some help.
Carrie had worked hard all of her adult life managing the 24-unit apartment building she owned. She cleaned, fixed, and rented the units over the years, expecting the building to support her in her old age.
What an unpleasant surprise it was for Carrie and her family to find that it didn’t work out that way, even though she owned the building free and clear. At the time Tim, the real estate agent, heard about her, she was 88 years old and living in California with her children.
She was diagnosed with Alzheimer’s disease and needed to go into a nursing home where she could receive special care that would cost her $3,000 a month.
The problem was her apartment building wasn’t producing enough money to pay for her nursing home. Despite hiring three different management companies in the past three years, the building was only making about $2,000 a month after paying the management company and all of the expenses.
Tim offered to list the property for Carrie’s Trust, which was how the property was set up, due to Carrie’s declining health. Her kids didn’t want to sell the property outright because a large part of the money from the sale would have to go toward paying capital gains tax.
Tim called me because he knew that I was always looking for situations where property owners were motivated and he knew he was unable to help Carrie himself. (I send Tim properties that don’t work for a creative, nothing down offer but that might work great for a listing and direct sale for him)
Step two is to “run the numbers” to see if you’ll make a profit. You’ll want to know with certainty that any property you get into is going to make you, not cost you, money. The best time to find this out is before you commit to a deal.
I looked closely at the income and expenses from the building to see if there was any way to improve the cash flow. I knew right away that because the management fees were close to $1,000 a month I could start off by managing the property myself and I’d be able to pay Carrie the $3,000 a month she needed and still break even.
The question was, could I make a profit?
The rents seemed to be low which meant that there was room to increase the cash flow after taking control of the property. I used an evaluator tool that helped me to determine the first year’s cash flow from the property.
The numbers showed this to be a winning deal.
Step three is creating an offer that uses the cash flow from the property to pay for the deal.
I offered Carrie’s Trust a “master lease” that would meet her needs and allow me to make a profit too. In return for our monthly payment of $3,000 and paying for all the expenses on the property, I received the exclusive option to purchase the building for $450,000, which was it’s current value based on its rental income. I simply used the income from the property to pay for both the expenses and the lease payment to Carrie’s Trust.
I immediately began lowering expenses and increasing rents. Rather than increasing everyone’s rent at once, I sent notices to 1/3 of the building each month for three months. Some tenants moved while others complained a bit about the rent increase but decided to stay. Most just paid the increased amount and were fine with it.
Within four months of taking over the building, raising rents to market levels and lowering expenses, I was able to increase the cash-flow an average of $85 per unit. This boosted the total monthly income from $7,100 to $9,182.
This was a monthly cash flow increase of $2,082 and I was thrilled to create an annual residual income of $24,987.
The cool thing about this is the cash flow would grow every year as the rents increased over time. This is as much money from one property as many people work all year to make.
This made me even more money than just the cash flow each month. You see, inncome property is valued in proportion to the amount of income it generates each year. When valuing an income property, you use something called a “capitalization rate” or “cap rate.”
In its simplest form, if the cap rate is 10, this means a building is valued at 10 times the amount of its annual cash-flow. (this isn’t the actual formula, but it’s the simplest way to explain it)
This means that the annual increase in cash flow of $24,987 made my building worth $249,870 more than it was worth just four months before. Pretty awesome… huh.
The nice thing about great cash flow like this is that you can afford to hire a property management company while you sit back and wait for the property to go up in value. That’s exactly what I did, and you can too, if you follow the three steps of the Master Lease Option.
First, find a motivated seller who owns a multi-unit building. Next, run the numbers to make certain you’ll make money each month if you were to lease out the property with the option to purchase. Finally, create an offer that uses the cash flow from the property to cover your monthly payments and expenses. Then increase the property’s value by lowering expenses and increasing the money it generates.