There are real estate investors who specialize in making profits, sometimes big profits from properties that they lease and do not own.
This cash flow from a lease can be extremely interesting. Often the lessee making a huge profit has a relatively small cash investment in the property.
The Usual Lessee
Take the position of the person acquiring property for use in a retail business or profession. For this person, the fundamental advantage of leasing over purchasing is the fact that the entire amount expended for leasing is currently deductible. On the other hand, if the property were owned, the owner would not be able to deduct any part of the purchase price. His entire cost would have to be capitalized, and could only be recovered through depreciation of the cost of the improvements over their life. The remainder would only be recovered on the disposition of the property.
An Estate for Years
A lease is defined as a contract between the owner of the land or building (landlord or lessor) and a tenant (lessee) in which the lessee agrees to pay a stipulated sum (rent) for the use and enjoyment of the property for a specified period of time. This is, for the lessee, very much like an ownership, and is also called an Estate for years.
Complicated Legal Contract
A lease is a complicated legal contract and it should not be entered into by either the lessor or lessee without professional assistance. All leases are different and so we cannot cover all of the possible combinations of items in a lease in this publication.
We can cover just the elements that can result from negotiating leases and subleases for profit.
The Original Lease
The original lessee may lease a property for a certain specified monthly rental amount. This lease is with the owner of the property.
As an example, what if a commercial building is leased for $10,000.00 a month? If the lessee could sub-lease the same property to another renter-user for a rent of $11,300.00 per month, then the original lessee would have a cash flow of $1,300.00 from this situation that is often called a “sandwich” lease. The original lessee is “sandwiched” between the owner and the user of the property.
This original lessee still pays the original specified monthly rental of $10,000.00 to the owner, but since he is collecting $11,300.00 from the sub-lessee under a separate contract, the difference of $1,300.00 is a monthly profit for him.
The Right to Sublease
As we pointed out, you need professional assistance to prepare the lease. If a “sandwich” situation is contemplated, a provision giving the tenant the right to sublease space is an absolute necessity in the lease agreement.
It is customary, in landlord prepared “form” leases, to preclude assignment and subletting. The ideal position for an active landlord who intends to provide competent continuing management to his real estate is to maintain this clause intact throughout the lease negotiation and thereby provide himself complete control of all assignments and sublettings, since none can be accomplished without his prior approval.
The usual original reason for the lessee to place the provision to sublet into the contract is the question about the future amount of space that the original tenant will need. If a tenant believes that he will need less space in the future, a sublease clause can be provided to solve the problem. The owner will usually agree in this situation, since the alternate provision might be for a cancellation of the lease.
A good counter-offer from the owner in this situation might be a “right of approval” of a sub-tenant. There might be other things that the owner wants into the lease regarding the use, etc., of a sub-lease tenant. All must be negotiated.
The Profits
• Our example of the commercial space leased for $10,000.00 and sublet for $11,300 showed a $1,300 a month cash flow.
• One speculator, when looking through an area for a commercial property, noticed a well-located house with an owner’s “for rent” sign. He inquired and leased the house for his own use. A few months later, he moved from the property, but was able to sub-lease the house for a $500 a month profit.