Ownership of real estate confers additional benefits other than use, possession, pride of ownership, tax shelter and leverage. One of the keys to income property is INCOME. Usually, the higher the leverage used to acquire property and to multiply depreciable basis, the lower the cash flow and income from that property. Sometimes a lease on a property can capture income better than fee simple ownership of it. Here’s an example:
Suppose I were to lease a 10,000 square foot retail outlet for 5 years with an Option to renew for 6 additional 5 year periods. Under IRC rulings,
I’d be able to depreciate this property as if I owned it. If my original lease were at $10 per foot and I were able to sub-lease it at $12- $13 per foot, I’d be realizing a profit of $20,000 per year.
As I might be able to charge increasingly higher rents, my lease would begin generating an income stream based upon the difference in what I was paying for the leased space and what I was receiving on my sub-lease. Under certain circumstances, my net after-tax cash flow eventually might be in excess of that being realized by the owner after I raised my tenants’ rents.
In the above example, it’s fairly easy to see how a ‘sandwich lease’ can transfer income from the owner to the lessee in the same way that a low interest, fixed rate assumable mortgage can transfer income from a lender to a borrower. In like manner, a mortgage or lease could also transfer EQUITY to the borrower once interest rates began to rise.
As more and more people became willing to pay higher and higher prices to be able to enjoy the benefits of a low interest rate assumable loan or fixed lease, the borrower and/or lessee would be able to profit from the difference between their older low fixed rate loan or lease and a new loan or lease which could be written at the higher market rates.
In any event, you can see how master leases can work to transfer financial yields between Lessor and Lessee even though few people understand this outside of Appraiser circles and major metropolitan areas where commercial leasing is prevalent. There’s also a tax angle that few people comprehend.
While a lease can act like a mortgage in that there’s a contractual obligation to make periodic payments to the lessor, there are distinct tax advantages. Rents received fall under the passive activity rental rules, thus, they can be sheltered by other real estate losses. Contrast this with a seller who receives Portfolio interest on an installment sale. It is extremely difficult to shelter portfolio income, hence, it is reduced by income taxes.
Learn more about Master Leasing at David Tilney’s Master Lease and Manage seminar in Dallas Texas May 19-21 SEE DETAILS HERE