Delaware Statutory Trusts (DSTs) are complex investments involving a lot of moving parts. Thankfully, the passive nature of these trusts shields investors from the most complicated processes. Even so, it’s important to understand these more nuanced aspects, such as Delaware Statutory Trust leases.
One of the most common arrangements is the master lease agreement, with many sponsors implementing this strategy to simplify management and compliance. Realized 1031 helps you gain an in-depth understanding of master lease contracts so you can stay informed and determine how such agreements affect your investment. Keep reading to learn more.
A master lease agreement is a contract that allows a master tenant to serve as a single tenant-landlord and sublease one or multiple properties in the DST. A traditional lease would mean the DST itself directly leases individual units or real estate assets to tenants. However, a master lease allows the DST to use the master tenant as an intermediary or middleman.
Master tenants are usually third-party or special-purpose entities created by the sponsor themselves. Their role is mainly to ensure the passive nature of the DST by preventing the sponsor and investors from directly managing the underlying properties.
Here are some of the specific uses for master lease agreements.
As we mentioned, master leases allow DSTs to maintain 1031 Exchange eligibility. Under Revenue Ruling 2004-86, sponsors and investors are not allowed to take active roles in the DST to maintain the investment’s passive nature. The existence of the master tenant provides a bridge between the sponsor and the tenants, maintaining operational flexibility without violating DST restrictions.
DSTs often own several properties. Monitoring the rental payments can be a complex undertaking, especially if the rates are variable. If a property has hundreds of individual tenants — a residential apartment complex, for example — the task can be overwhelming. Sponsors can simplify this with a master lease agreement. The burden falls to the master tenant, who is most likely already equipped with systems that help manage tax payments and ensure a predictable cash flow, even if there are occupancy or collection fluctuations.
The master lease is a structural solution that keeps everything compliant and efficient, especially if the DST has assets under a wide range of asset classes or sectors. If the sponsor attempts to handle these on their own, then this might constitute active management.
Another prohibited practice under Revenue Ruling 2004-86 is lease renegotiations after the DST offering closes. However, in DSTs with many tenants, this process is inevitable. Master lease agreements allow sponsors to avoid doing the lease renewals or renegotiations themselves, preserving 1031 Exchange eligibility.
Having a master lease makes DST tenant relationships easier and compliant. However, the master tenant’s services are not free. Compensation comes after they collect from the actual tenants. The master tenant keeps a spread as compensation for providing operational support.
Of course, the better the underlying properties perform, the higher the gross revenue of the property. By extension, the master tenant’s margin also increases. There is an incentive in providing high-quality property management and administration solutions, so many master tenants employ tactics that help ensure excellent property performance. Otherwise, their income will also dip.
However, it’s important to know that master leases are not absolute shields. If property-level performance declines significantly, the master tenant may struggle to make full lease payments, which could affect investor distributions.
DSTs have a variety of lease agreements available, but master lease contracts are popular for a few reasons.
DST 1031 exchange lease structures may vary from one offering to another, but master lease agreements remain the most popular type. These arrangements simplify operations, ensure compliance, and enable predictable cash flow for beneficial interest holders. With this understanding, you can better evaluate DST offerings and choose ones that align with your risk tolerance and income goals.
https://mf.freddiemac.com/docs/multifamily_legal_fyi_delaware_statutory_trust_august_2014.pdf
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
https://www.contractscounsel.com/t/us/master-lease-agreement