A master lease stops an insolvent tenant from keeping the good sites and returning the bad ones, until aggregate cover falls below the threshold and it returns them all.
A master lease is worth what it stops a tenant in insolvency from doing: keeping the profitable sites and handing back the weak ones. On an illustrative ten-site portfolio paying €10.00m of rent, a tenant on individual leases would hand back three sites and €2.10m of rent, a loss of €7.90m in present value after re-letting. At a 15 per cent probability of insolvency that is an expected €1.19m, 0.77 per cent of the €153.8m price, which a master lease protects, provided it holds as one indivisible contract.
Worked in full in Sale and Leaseback by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Under US Chapter 11, where section 365 of the Bankruptcy Code lets a debtor assume or reject each unexpired lease, and in other regimes that give an insolvent tenant or its administrator a similar choice, a tenant under court protection can decide which leases to keep and which to give back. With ten separate leases it keeps the stores, plants or warehouses that earn their rent and rejects the rest, and the landlord is left with the worst buildings, empty. A master lease puts all ten sites in one contract: the tenant must keep all of them or give back all of them. If the portfolio as a whole is worth keeping, the weak sites ride along with the strong.
Whether a court treats a master lease as one contract is a legal question that turns on drafting, a single rent, cross-default and the parties' evident intent, and on local law. The arithmetic below values the protection if it holds; the lawyers decide whether it does.
Sites rejected under individual leases = sites whose EBITDAR / rent is below the tenant's keep threshold
Loss given insolvency = PV of their contract rent − PV of re-let rent after the void + PV of re-letting costs
Value of the master lease = probability of insolvency × loss given insolvency
In Excel, the re-let rent: =Rent*Ratio*PV(r, Years-Void, -1)/(1+r)^Void
| Site | Rent | EBITDAR | Cover |
|---|---|---|---|
| 1 | 1.40 | 3.64 | 2.60x |
| 2 | 1.30 | 2.86 | 2.20x |
| 3 | 1.20 | 2.40 | 2.00x |
| 4 | 1.10 | 1.98 | 1.80x |
| 5 | 1.00 | 1.60 | 1.60x |
| 6 | 1.00 | 1.40 | 1.40x |
| 7 | 0.90 | 1.08 | 1.20x |
| 8 | 0.80 | 0.80 | 1.00x |
| 9 | 0.70 | 0.56 | 0.80x |
| 10 | 0.60 | 0.36 | 0.60x |
| Portfolio | 10.00 | 16.68 | 1.67x |
The tenant keeps any site covering its rent 1.20x or more. Rejected sites re-let after a void of 1.5 years at 75 per cent of the contract rent, since sale and leaseback rents are often set above market, with re-letting costs of half a year's rent. The lease has 15 years left, the discount rate is 7.0 per cent, the cumulative probability of insolvency over the term is 15 per cent and the portfolio is priced at a 6.50 per cent yield.
Step 1, which sites go. Sites 8, 9 and 10 cover their rent 1.00x, 0.80x and 0.60x. Under individual leases they are rejected: €2.10m of rent, 21.0 per cent of the total. The seven sites kept cover 1.89x, a healthier tenant than before.
Step 2, the contract rent lost. Fifteen years of €2.10m at 7.0 per cent, an annuity factor of 9.1079, is worth €19.13m.
Step 3, the re-let rent. €2.10m × 75 per cent from year 1.5 to year 15, a deferred annuity factor of 7.7292, is worth €12.17m.
Step 4, re-letting costs. Half a year's rent, €1.05m, paid at year 1.5: €0.95m today.
Step 5, loss given insolvency. €19.13m − €12.17m + €0.95m = €7.90m, 41.3 per cent of the rejected sites' contract rent value.
Step 6, the master lease. Aggregate cover is 1.67x, comfortably above 1.20x, so the tenant keeps the whole portfolio and the landlord loses nothing. The expected value of the difference is 15 per cent × €7.90m = €1.19m. That treats the insolvency as if it happened today; one later in the term leaves fewer years of rent at stake, so the figure is an upper bound.
On these assumptions a buyer can pay up to €1.19m more for the portfolio on a master lease, 0.77 per cent of the €153.8m price, before adding anything for the lower risk of the remaining income. The figure is the probability-weighted cost of the tenant's option to cherry-pick, and it is concentrated in the three sites that a building-by-building underwriting would already have flagged.
| EBITDAR fall | Aggregate cover | Master lease | Individual: sites given back | Individual: rent given back, €m |
|---|---|---|---|---|
| 0% | 1.67x | kept | 3 | 2.10 |
| 15% | 1.42x | kept | 5 | 4.00 |
| 25% | 1.25x | kept | 5 | 4.00 |
| 35% | 1.08x | all given back | 7 | 6.10 |
The master lease is a cliff. Up to a fall of about a quarter in EBITDAR it protects every euro of rent, and its value grows as conditions worsen: at a 15 per cent fall the individual leases would lose €4.00m of rent and €15.05m of value. Below 1.20x aggregate cover the tenant gives back everything, and the landlord's loss, €37.63m on the same re-letting assumptions, is €14.67m worse than the €22.95m it would have suffered with individual leases. A master lease swaps a series of partial losses for one large one in the tail.
| Probability of insolvency | Re-let at 60% | Re-let at 75% | Re-let at 90% |
|---|---|---|---|
| 10% | 1.03 | 0.79 | 0.55 |
| 15% | 1.55 | 1.19 | 0.82 |
| 25% | 2.58 | 1.98 | 1.37 |
The more over-rented the weak sites, the more the master lease is worth, because their re-letting rent is furthest below the contract. That is the usual position in a sale and leaseback, where the seller chooses the rent.
Underwriting the master lease on aggregate rent cover alone. A 1.67x portfolio cover hides three sites below 1.00x, and it is the distance between those sites and the rest that gives the master lease its value, and the distance between aggregate cover and the keep threshold that sets where the cliff is. Report site-level cover next to the aggregate, and test both the base case and the tail.
Rent cover by site and at the signing entity, with the master lease arithmetic, is in the free workbook for this book. For cover itself, see how rent cover is calculated in a sale and leaseback.
To stop a tenant in insolvency from keeping profitable sites and rejecting weak ones. On the worked ten-site portfolio, three sites covering their rent 1.00x or less would be given back under individual leases, losing 2.10m of rent a year and 7.90m of value; one indivisible lease keeps them in while aggregate cover stays at 1.67x.
Yes, in a deep downturn. If aggregate cover falls below the tenant's keep threshold the tenant rejects every site at once. After a 35 per cent fall in EBITDAR the worked portfolio's cover is 1.08x, and the landlord loses 37.63m instead of the 22.95m individual leases would have cost, 14.67m more.
Up to the probability of tenant insolvency times the loss from cherry-picking. At 15 per cent and a 75 per cent re-letting rent that is 1.19m on a 153.8m portfolio; at 25 per cent and a 60 per cent re-letting rent it rises to 2.58m. It is worth nothing if the lease would not hold as one contract.
This article is one calculation from Sale and Leaseback. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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