Tax law requires that the Delaware Statutory Trust (DST) trustee be prohibited from taking certain actions with respect to leasing, financing and capital-raising for the property. Also, the beneficiaries have no control over the operations of the mortgaged property. Therefore, either a master lease or a long-term triple-net lease to a credit tenant is required.
In the case of a master lease, the master tenant (generally an affiliate of and controlled by the sponsor) will sublet the property to residential or commercial tenants. The master tenant also handles maintenance and repairs, and contracts with a management agent (also often an affiliate of the sponsor). In general, the master tenant is empowered to do everything that an owner of the property would be empowered to do. Such a master tenant/master lease arrangement satisfies the requirements of the law, is very attractive to institutional lenders, and in addition, eliminates the concern raised in TIC transactions as to how to ensure the unanimous consent of the tenants-in-common to certain necessary management actions.
Special Purpose Entity Structure
The master tenant would also be structured as a Special Purpose Entity, adding yet another layer of bankruptcy protection for the lender. Because most master tenants would only be minimally capitalized, the sponsors will be the parties that own and control the master tenant and have the requisite net worth and liquidity to satisfy lender requirements.
The master lease will generally provide for rent to be paid by the master tenant to the DST in a set amount equal to debt service plus a market rate of return. The master lease structure economically incentivizes the master tenant to maximize the mortgaged property’s net operating income because the master tenant retains all net operating income over and above debt service and rent payments under the master lease, and incentivizes the master tenant to cover short-term operating deficits to protect its desired return and its valuable investor reputation in the industry.
Self-Reserve
Additionally, the better sponsors self-reserve from net operating income (over and above typical lender replacement reserves) for unanticipated repairs and uninsured losses, because there is no real ability to negotiate changes in the master lease terms and rent payments with the DST trustee.