Credit Lease Financing or Credit Tenant Lease (CTL) Financing:
Bond Structure: There are several approaches to placing a loan supported by a long-term lease from a credit tenant. Before going into these options let’s understand what is different about a true CTL Financing transaction versus a traditional real estate loan.
The idea is to examine the specific lease terms from an investment grade tenant (e.g. Wal-Mart, Walgreens, Home Depot). First, determine what expenses the owner of the property (you) will have as a landlord. If the lease is truly NNN we can often apply 100% of the rent towards the principal and interest of the new CTL loan. Under typical commercial real estate loans the lenders will want to see some coverage over and above the net income. For example, a Debt Service Coverage of 1.25x or 1.30x vs 1.0x in an NNN credit lease transaction. This approach will often provide higher loan proceeds in a credit tenant lease financing. The focus is on the net cash flow and not necessarily the actual value of the property.
High leverage:
You often hear you can borrower up to 100% of the value of the real estate. This is true, however, the reality is we have not witnessed in recent years any transactions that did not require substantial down payment. The lenders will assume the tenant will not extend or renew. So, the primary lease term is what the CTL lender will focus on.
Tenant Early Termination and Bondable Lease Structure:
Many credit tenant leases allow the tenant to cancel or terminate the lease should certain events occur during the primary lease term. In credit lease financing transactions we want to take an NNN lease and essentially convert this NNN lease to a synthetic Bondable Lease. A synthetic Bondable Lease eliminates any opportunity that the cash flow will be interrupted (assumes the tenant stays financially strong and does not default). Typical provisions found in most NNN leases would allow the tenant to terminate the lease should all or a portion of the leased property be subject to condemnation. Another provision often found in NNN leases would allow the tenant to cancel or terminate the lease in the event of a casualty loss. Specialty insurance products are purchased at closing that protect the lender (bondholder) in the event the tenant exercises the right to terminate (pursuant to terms found in the lease) for condemnation and/or casualty loss. The goal is to convert this transaction from a Loan to a Rated Bond. This is significant because credit tenant lease lenders can book these transactions as bond on the company books. If they can book the transaction as a loan vs a bond most are constrained to 75% of the value.
Below is a simplified example showing how much in loan proceeds a specific NNN investment might be able to support:
- Base monthly NNN rent: $25,000.00
- Number of Months remaining in primary lease term: 162
- Anticipated Interest Rate on new loan: 5.00%
- Present Value of this income stream is equal to $2,940,774.36
Call for a free present value Excel Model that might provide you will some assistance in determining the present value of the net rental income stream.
Residual Value Insurance:
How can you borrow more money using this Bond Structure? You can bring in Residual Value Insurance (“RVI”). This is a rated company that allows a small balloon balance. The loan will be scheduled to mature with the final lease payment. The plan is for the property owner to make arrangements to pay off the balloon balance at maturity. Should the owner not be able to pay off the loan at maturity the RVI company will step in and pay off the loan. The RVI company will look towards the property to make them whole. How much will the RVI company advance? This turns into a real estate question. They will assume additional wear and tear on the building. Keep in mind the physical improvements may offer very little value. The focus is often on the unimproved land value. The RVI company does not take much risk so you should not expect to receive more than 25% of the going in value as the balloon balance.
Obtain credit ratings for companies not presently rated.
For loans over $7,500,000 +/- with a tenant with very strong financial statements that do not have public credit ratings we can help obtain a private placement rating. Companies obtain credit ratings to assist in lowering their cost of borrowing. If a financially strong company does not see the need to incur the expenses of credit ratings they simply do not obtain public ratings.
You can sign up for a free account with several of the credit rating services such as Standard and Poors :
https://www.standardandpoors.com/en_US/web/guest/home
If you move forward with a zero cash flow mortgage or a near zero cash flow mortgage we recommend you review the income tax consequences this might have on you.
CTL Construction Loans:
In addition to traditional Credit lease financing bond construction loans are available utilizing this same process. Generally, the entire loan is funded at Closing. The interest rate is fixed and loan draws are permitted as construction progresses. As mentioned the entire loan is advanced so the interest meter is running on the entire loan amount with very little return available on the re-investment of the unused loan proceeds. So, it is important to minimize the negative arbitrage by completing construction as fast as possible once the loan closes.
A/B Structure:
In an A/B structure we have two loans (two notes) The A is the senior piece and the B piece is a second or mezzanine piece. This allows the borrower to obtain hire proceeds and sometimes will at more favorable terms when flexibility is required. The lender will look at the similar methodology as found in the Bond Structure above. The B lender will focus on the real estate value at the end of the primary lease term. The residual value of the real estate must be determined on a case by case basis. There is no fast and simple system or approach to arrive at this value. Ask yourself what would this property be worth at the end of the 15-year lease, vacant, with 15-year additional years of use. Will it need a new roof? Is there a demand for the building configuration or will this be a land play in 15-years?