28. Effects of Long-Term Lease to the Syndicator or Seller on the Value of Your Investment

At times you may examine the brochure very care­fully. Yet when you read about the long term lease you will notice that the syndicator, who is also the tenant of the syndicate, does not take in much more rent than he pays to the syndicate. Why then does the syndicator go to all the trouble of dealing with the tenants while the rewards seem so small? The answer lies in growth or an­ticipated growth.

If over the years the syndicator can increase substan­tially the rents which he collects and can continue to pay the same rent to the syndicate, he will make a substantial profit. In many cases he will be able to do just that. This example is oversimplified. The long term net lease pro­vides almost invariably that the syndicator-tenant must also pay increased taxes and expenses, so that the syndi­cate gets enough money to pay the projected distribution to its investors. Thus the expenses of the syndicator-tenant will probably also go up. However, if the rents which he collects go up more than his expenses he will be able to realize a profit.

We must examine an illustration to appreciate the effects of the long term net lease on the value of your in­vestment. Let us assume that this syndicate bought an apartment house development with a rent roll of $1,000,000. This is by no means unrealistic. Apartment house projects with far larger rent rolls have been syndi­cated. The syndicator figures that all expenses including taxes amount to $880,000. So this property will net $120,000. This syndicator will prepare a net lease from the syndicate to a corporation controlled by himself. The corporation will pay to the syndicate $100,000 a year, which will be sufficient to give the investors a 10% distribution on their investment. So the syndicator gets $20,000 a year for himself. This is not bad.

Let us examine the picture 5 years from now. Rents have gone up 20%, so that the long term tenant—the syndictor's corporation—takes in $1,200,000 in rents. If the expenses had remained unchanged, that is $880,000, the syndicator would now make a profit of $220,000 a year but continue to pay the same $100.00 to the investors. His yearly profit would increase eleven fold. But let's not dream. Expenses go up too. The syndicator has to foot the bill for higher taxes and probably he has to pay more to his employees and for supplies. So let us be realistic and let us assume that all expenses have also gone up 20%. The expenses would thus be $1,056,000. The pay­ment under the net lease to the syndicate would still be $100,000. The syndicator would then have a yearly profit of $44,000. So even if expenses and income go up in the same proportion, the syndicator-tenant has increased his income from $20,000 to $44,000, i.e. 120%.

Where are you when the syndicator increases his yearly profit by 120%? You still get your same 10% on your in­vestment, unless there is some further opportunity for the investors to share in the profits. But chances are your distributions will buy you a lot less than at the time you bought your syndicate participation.

The syndicator's leasehold is something that he can sell too. Since the leasehold's income may have increased by 120%, the leasehold is worth about 120% more for the syndicator. But not for you. What about your syndication unit? That unit still brings in the same 11,000 for every $10,000 invested. It has not gone up in value.

What has happened here is of supreme importance to you. The growth factor has been taken away from you. You will get the same number of dollars every year. But your purchasing power over the years is going to dwindle. Sometimes a long term lease is given to the syndicator, sometimes to the seller or builder. Long term leases, when given to an insider, have usually one thing in common. They cut the growth potential of your investment. The language of each contract will differ, but the words net lease, long-term lease or lease-back will appear in your brochure. We want to be sure that you recognize provi­sions of a long-term lease. So we are giving you below some excerpts from a syndicate brochure which contained a long-term lease-back to the builder.

The partnership will not operate the building. Si­multaneously with the delivery of the deed, the build­ing will be leased to the builder for an initial term of twenty years with four renewal periods of twenty-one years each. This will be a net lease with a rental, pay­able to the Partnership, of $57,500.00 per year payable monthly. . . . As the above rental is received, there will be distributed to the Limited Partners a 10% return upon their capital contribution of $52,500.00 annually.

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