Single Credit Tenant Loans (CTL) Financing:
A property that is supported by a long-term lease from a tenant that carries an investment grade credit rating is often eligible for CTL loans. CTL financing focus is on the income stream generated by the lease. Leases can be on NNN terms; meaning the tenant pays all expenses and maintenance related to the property or on NN terms which would indicate the tenant pays most of the property related expenses with the Landlord responsible for some of the expenses. On NN leases the Landlord often is responsible for repairs to the structure, foundation and sometimes the roof. This varies and is lease specific.
The financial strength of the tenant and related credit rating is important, but no less important is to understand the specifics of the lease. The lender will focus on the term remaining on the primary lease term (ignoring lease renewal options), the “outs” or escape provisions found within the lease that would allow the tenant to cancel or otherwise escape liability under the lease. More times than not the leases have provisions that would allow the tenant to cancel the lease in the event of a significant casualty loss (e.g. fire, storm damage) or if part or all of the subject property is condemned. Under a typical real estate loan the lender underwrites the risk of one of these events occurring, while in a CTL transaction the lender requires these risks to be removed. Specialized insurance products are purchased to protect the lender from an interruption in net cash flow due to either a casualty loss or condemnation in CTL financing transactions.
As stated earlier the lender will focus on the net cash flow. This means the lender is not constrained by the loan to value as up to 100% of the value of the property is conceivably possible for financing. The constraint will be on how much of a loan could the net rental income from the lease service? If the lease is on NNN terms most lenders can underwrite to a zero cash flow, or 1.0x to 1.0x – wherein all of the net cash flow is applied towards the loan payments over the remaining lease term. If the lease terms are NN where the landlord has some responsibilities the lender may require a debt service coverage ratio (DSCR) of 1.05x as an example. If you decide to move forward with a zero net cash flow mortgage loan we recommend reviewing the transaction with your financial adviser. Much of the income being applied towards your loan payments may be subject to income taxes.
We can forward to you a simple calculator that will help you size up the net cash flows and back into the loan amount. Just call or send an email requesting the CTL Calculator written in Excel. (913) 402-7077 or Mike@CaffreyLoans.com.
The lender will want to study the lease in fine detail. The lender will be searching for any provisions that would allow the tenant to escape liability or allow for an early termination. For example, Walgreens https://www.walgreens.com primary lease term runs for 75-years with an early termination option at the end of 25-years. In this example the lender will assume Walgreens will go dark at the end of the first 25-years of the lease. We have seen some leases from tenants that carry investment grade credit ratings that permit transfers or allows for other tenants to assume the lease without landlord’s prior consent if the replacement tenant meets certain financial criteria. The criteria might be tied to financial strength of the replacement tenant however the replacement tenant may not carry investment grade credit ratings. One example is a QuikTrip:
CAFFREY & CO. ARRANGES $1.6M ACQUISITION LOAN
Some tenants have lease provisions that would discourage a lender from moving forward under a CTL financing structure. Some tenants will not renegotiate these terms out of the lease while others will. If you are involved with the actual up front negotiations with the tenant please send us the draft form as early as possible for review. We can often share prior experiences with negotiating specific terms in or out of a lease with specific credit tenants.
While the focus of the lender will be on the lease terms and credit strength of the tenant. It may be possible to stretch the amortization beyond the remaining lease term allowing for a balloon balance. There is no standard rule of thumb or set percentage how large of a balloon balance might be available. Specialized products “Residual Value Insurance” (RVI) may be available starting at $1,000,000. The RVI provider will focus on the value of the subject real estate at lease maturity, assuming the property is dark, or vacant. They might be willing to advance up to 50% of the value of the vacant property increasing the proceeds available to lend. The costs for this RVI can range between 4% and 7% of the amount of the balloon. Should the tenant not renew and the property goes dark the RVI Company will step in and either pay the loan balance off or continue to make the monthly payments while they begin the process of liquidating the property. Typically you would refinance the property or sell the property to pay-off the loan before the loan is in jeopardy of going into default.
Highlights of CTL Loan Programs:
- Term Loan equal to and with RVI in excess of the lease term.
- Investment Grade tenants with credit ratings at or above “Baa3” from Moody’s or “BBB-“ from Standard and Poor’s.
- Loan Amounts: $1,000,000 and no upper limit.
- Debt Service Coverage Ratio: 1.0x to 1.05x
- Leases can be NNN or NN structures.
- CTL Loans are generally assumable by qualified investors.
- Early Rate Locks are available 60-days in advance and up to 18-months on a case by case basis.
In transactions over $7,000,000, it is possible at borrower expense to obtain credit ratings on tenants that do not presently carry investment-grade ratings on their own. Credit ratings cost money to obtain. The reason companies obtain public credit ratings is to lower their costs of funds or to lower the rental rates. There are many financially strong companies that are not rated by one of the major rating agencies. We can assist with this process. The audited financial statements of the subject company will need to be made available for the lenders review the rating agency’s inspection.
With the use of specialized loan products to remove the risk of any interruption of payments due to a casualty loss, a condemnation, or failure to retire the debt at maturity due to a balloon balance effectively converts a lease from either an NNN or NN to a Bondable lease. That is no matter what if the tenant performs the lender will receive the scheduled payments no matter what else happens.
Why do you would you want to consider CTL financing? Typically because you want higher dollars than the traditional 75% loan to value. If you need to borrower smaller dollars, say below $2,000,000 are loans available? Yes, often these come with some personal recourse requirements.
CTL loans & CTL financing are just a few of the many loan products available from Caffrey & Company LLC. Feel free to call or email Mike Caffrey for additional information: (913) 402-7077 or Mike@CaffreyLoans.com.
For additional details on other loan products go to our web site: www.caffreyloans.com.
Details on other specific loan products: https://www.caffreyloans.com/loan-products/.
And details on CTL financing, more in-depth: https://www.caffreyloans.com/credit-lease-financing-credit-tenant-lease-ctl-financing/
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.
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 :
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.
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?