What’s a Master Lease & Core’s Lease Agreements

Wally Smith:
Describe when you would have a master lease. What’s a master lease, and why do you have it in a DST structure?

Jeff Montgomery:
So, I mentioned my history wasn’t on the DST side, so I’m learning along with everybody else. But my rudimentary understanding, or layman’s understanding, of what a master lease is, is can be explained similar to a ground lease.

Wally Smith:
Okay.

Jeff Montgomery:
In that ground lease, you have a property owner. You have a landowner. When you’re buying the property, you’re buying the asset, not the land. Well, the DST investor owns the asset. So they own 100% of the asset. What the MT, the master lease, is paying at lease-on is the operating of the asset. The DST owns it. The DST investor owns it. Us as a sponsor are managing income, through expenses, through all the financial side of the deal to a net number. And then we’re returning back to the DST investor a lease or a payment for getting [inaudible].

Wally Smith:
Well, that makes it real clean for the DST sponsor and for the investor, to be able to get one payment. I think it’s also a part of the DST requirements themselves, is you can’t change leases, is you got to have a lease on that property. So what do you do when you’ve got storage units or apartments or college kids moving in and out? Right? So that way, you’ve got one master lease who’s taking care of all of that in-and-out stuff. But it satisfies that DST. One of the things I like about the master lease is, again, is that pricing elasticity. When somebody moves out, I mean, you see the rents can go up 5, 10% in a multifamily.

Jeff Montgomery:
Right. Yeah, so from the property management operating side of the asset, this is an advantage of multifamily.

Wally Smith:
Absolutely.

Jeff Montgomery:
You’re not locked in for a five-year lease. Our typical lease averages from 10 months to 12 months to 14 months, kind of dependent on the market. But a good average is 11, 12 months. And you’re able to reset, based off that. So whether the tenant moves out, you have a new lease coming in, it resets to the current market. Excuse me. It’ll reset to the current market. If you have a renewal, you don’t always get to the top of the market, but you get a lot closer to that. So by having the property management side, the owner, the asset side leases constantly turning, you don’t end up with a large loss to lease or a large discount to where the market is.

Wally Smith:
And so most of them are 10, 12, 14 months, in that range?

Jeff Montgomery:
Excuse me. Yeah, so our typical lease, multifamily is 11, 12 months.

Wally Smith:
Okay. Typical one-year sort of thing.

Jeff Montgomery:
We’ll lease anywhere down from six months to 12 or 14 months. Difference being, we’ll price different premiums based off that. And another aspect of having this flexible lease is we will schedule leases based off seasonality. So Denver is a seasonal market. Winter’s not the time you want to be doing most of your leases. We’ll anticipate that when we’re signing spring leases. We might shorten them up a little bit so that they expire in summer. Or-

Wally Smith:
[inaudible].

Jeff Montgomery:
… we may push a later lease in the year to expire later, so that we’re not hitting that winter window. So that-

Wally Smith:
Do you guys use that, I mean, that latest software that… My daughter went out and got an apartment. And it was her first apartment after she got out of college. And she checked. It was in the Denver Tech Center area. And so she looked at what the price was, and we’re talking about it, and she checked back four hours later, and the price had changed. And the next morning, the price had change. It was just the flexibility of that. I think it must be the, I don’t know, software systems that are constantly changing that.

Jeff Montgomery:
So, rent optimizers, LRO.

Wally Smith:
There you go.

Jeff Montgomery:
Yeah, LRO and YieldStar, I believe, are the two main players in that today. That’s really taken off. You used to have, years ago, an on-site staff would set the rents. They’d call around to the market. They’d say, “Hey, what are you leasing for?” And we’d play the game and try and set where the rent should be on every single lease. It’s inefficient, also allows human error and all that kind of stuff.
So what the lease optimizers do is put an algorithm together, where they say, “I know, based off the competitors,” who are also using the system anonymously, baking that in there and saying, “Hey, market rents should be around this. You have vacancy at 10% in your two-bedrooms, so that’s a higher vacancy. So we need to lower the rent a little bit to entice some more volume there. Your one-bedroom is full. You have one unit available. We can try and get a higher rent on that.” This is going into a algorithmic program that initially sounds like, “Does this really work?”

Wally Smith:
Oh, but it’s similar to the way the airlines price their seats. I think it got really strong with the storage units. They were doing a lot of that as well. That’s interesting. Multifamily with the DSTs had, well, until just a few months ago, it was kind of lagging as far as the yield is concerned. And there wasn’t much to drive it on the upside. But I think with the inflation and with what we’ve been talking about here, the elasticity of that really does make it one of the better inflation hedges.

Jeff Montgomery:
So kind of what we were discussing with the being able to schedule leases and reset leases as they turn over on an individual side, unlike an office tenant, unlike an industrial tenant, where it’s a longer-term lease with certain steps, we’re able to ride with that inflation. And that goes back to what the investors were asking for on doing a bonus rent profit-share program, was they were wanting to know that multifamily is a hedge against inflation. The reason for the hedge is because of the shorter-term leases and the more turnover. “Let’s participate in that.” And so yes, on the multifamily side, from trying to hedge inflation and preserve capital, it’s a better avenue than some of the other asset classes, especially going into the environment where it might be a little bit cooler for the next year or two.