Long-Term Lease to Syndicator or Insider Is No Guarantee of Income to You

.
You may believe that in view of the long term lease to the syndicator or to another insider you are at least assured of receiving your monthly distributions for the term of the lease. There is no such assurance in most of the cases examined. Bear in mind that the lease is made to a corporation controlled by the syndicator or an insider. In most cases that corporation has no other assets except the lease. Indeed, the brochure will usually disclose the fact that in spite of such long-term lease your distributions depend entirely and solely on the ability of the property to produce income.
Even if the corporation, which is the tenant under the long term lease, has assets, you have no assurance of rental income and distributions to you. In such case the long term lease will probably contain the following clause, (the words in parentheses were added by us to make the meaning clear) :

The Tenant {Syndicator) may assign the lease without the landlord's {the investors') consent and upon such assignment and assumption by the assignee of the lease (a dummy), the Tenant (syndicator) shall have no further liability thereunder. The legal effect of that clause is that the long term tenant (the syndicator) will be relieved of all obligations under the lease, including the obligation to pay rent, as soon as someone else takes over the lease. The syndicator does not have to find someone with money, not even someone solvent. The tenant could create a new dummy corporation without any assets whatsoever and have that corporation assume the lease. The very purpose of the above clause is to give the syndicator-tenant an opportunity to cancel the long-term lease at any time.

You have then, as a practical matter, the following situation. If the leasehold is profitable, the syndicator will keep the lease and take that extra profit over the lease's term. If the leasehold continues to be profitable, the syndicator-tenant will exercise the successive renewal options which frequently run for as long as 78 years. If the leasehold should turn out to be unprofitable, the syndicator's corporation will fail or assign the lease to someone who cannot fulfill it. The syndicator or insider almost never incurs any personal risk or liability under the customary form of the long-term lease, or if he does, he limits it to, the first few years.

Inflation Clauses

In many cases, the long term net lease will have a so-called inflation clause. It provides that if the lessee (the syndicator's corporation in our case) collects rents in excess of a certain sum, that the investors get a part of such excess rents. Read that clause carefully. How much more rent is there to be collected before the investors get additional payments? If the investors were to get an increase when the rents collected by the syndicator-lessee go up by 50% the investors may have to wait a long time before they see a dollar of increased rent. Rents do not go up 50% overnight.
When you see an inflation clause you must first determine what the chances are of collecting higher rent. If there is a sub-tenant with a long term lease at a fixed dollar amount, the chances are nil. If the building is a new luxury development, you may have a question mark when the leases come up for renewal. If you have rent controlled property, your chances in the long run depend on an easing of the law.

Next: How the "Inflation Clause" Works