Credit Tenant Leases Pose Less Risk to Lenders And Provide Borrowers With Better Terms
A credit tenant lease, or CTL, is a type of long-term lease in which the tenant's creditworthiness is used as collateral for a commercial real estate loan. The lender, typically a bank, life insurance company, or CMBS lender, agrees to make a loan to the owner of the property leased by the credit tenant. CTLs are often used by major corporations, educational institutions, or government agencies who want to lease space in high-end office buildings or large retail centers. Credit tenant lease terms are typically between 10-15 years.
Due to the fact that CTL loans are considered less risky than traditional commercial real estate loans, lenders will often offer a borrower LTVs up to 100%, DSCR requirements as low as 1.0x, as well as reduced interest rates. Credit tenant loans are typically non-recourse and lenders will often waive the replacement reserve requirements.
Requirements for Credit Tenants
As previously mentioned, the creditworthiness of the tenant is the key factor in determining whether a lender will issue a CTL loan. The lender will typically require that the tenant have a strong credit rating in order to qualify for a CTL. Typical corporate credit requirements for credit tenant leases are between AAA and BBB.
In addition to creditworthiness, the terms of the lease should be such that the tenant is likely to remain in place for the duration of the loan (usually 10-15+ years). For these reasons, CTLs are not typically used for properties that are leased to small businesses or individuals.
For especially large CTL loans, often $7.5 million+, a borrower with strong financials that do not yet have a public credit rating may be able to get a private placement rating in order to qualify for CTL financing.
Types of Credit Tenant Leases
CTL leases can come in several varieties, including bond leases, triple net (NNN) leases, double net (NN) leases, and modified gross leases (MG leases).
Bond Leases: Bond leases are the most common type of CTL. In a bond lease, sometimes referred to as an absolute net lease, the tenant agrees to pay all operational and non-operational costs. Bondable leases are the most extreme form of lease, as the tenant is usually responsible for repairing the building even in the cases of disasters or “acts of God” such as fires, hurricanes, tornados, or other natural disasters.
NNN Leases: A triple net lease, or NNN lease, is another type of lease used in credit tenant lease situations In a triple net lease, the tenant is responsible for paying all property taxes, insurance premiums, and common area maintenance fees in addition to the rent. Unlike bond leases, NNN leases typically allow the tenant to terminate their lease in the event of a natural disaster or the partial destruction of the property.
NN Leases: A double net lease, or NN lease, is similar to a triple net lease, but the tenant only pays two of the three expenses. For example, the tenant may be responsible for paying property taxes and insurance premiums, but not common area maintenance fees. Required DSCR ratios may be higher for double net leases, and replacement reserves may be required due to the increased risk.
Full-service leases, sometimes called gross leases, which place the financial burden of nearly all operational costs onto the landlord are rarely (if ever), used in CTL scenarios. This is due to the fact that they are riskier for the borrower, and hence, the lender.
Prospective Terms for CTL Loans
Typical terms for a CTL loan include:
Size: $5 million minimum
LTV: Up to 100%
DSCR: 1-1.05x (determined by lease structure)
Term: Coterminous with remaining lease term, generally 10-25 years
Amortization: Loans are fully-amortizing in most scenarios
Lease: Bondable, NNN, NN, Modified Gross
Prepayment Penalty: Yield maintenance at U.S. Treasury Rate + 50 bps
CTL Financing Rates: Starting at 4.48%
Assumable: CTL loans are typically assumable for purchasers, usually for a 1% fee
Recourse: Most loans are fully non-recourse with standard “bad boy” carve-outs
Construction Loans:
Typically offer leverage up to 90% LTC.
Loans are interest-only (I/O) during the construction period.
Construction-to-permanent loan structures are offered with one closing.
Loans are recourse during the construction period only and become non-recourse once the building is complete and fully leased.
Surety bonds are required for all contractors.
The credit tenant must generally sign a CTL lease prior to construction.
The Pros and Cons of Credit Tenant Lease Financing
Credit tenant lease financing has both a variety of advantages and disadvantages. Some of the pros and cons of CTL loans include:
Pros:
Highly competitive interest rates.
Long loan terms, often up to 30 years.
Extremely high leverage allowance, up to 100% LTV.
Low DSCR requirements.
Cons:
Potentially long closing times and significant documentation requirements.
Loans applications may fall apart before closing due to poor underwriting (particularly if a CMBS/conduit lender is used).
Lenders often misquote interest rates by quoting a different U.S. Treasury rate than the one the loan will be based on, or by misstating the number of days over which the interest rate will be calculated.
In general, a credit tenant trying to obtain a CTL loan should work with a dedicated CTL lender. This increases the chance that the loan will successfully close and reduces the chance that a potential borrower will receive a misleading interest rate quote. Dedicated CTL lenders often have teams of in-house underwriters who understand exactly how bonds are rated and can guide the borrower to a quicker, less painful closing.
CTL Construction Loans
CTL loans are available for construction projects, though they typically have additional requirements, making the financing structure somewhat more complex.
Additional requirements for CTL construction financing often include:
Lower Leverage: CTL construction loans are typically issued up to 90% loan-to-cost (LTC).
Construction Fee: In contrast to already existing structures, CTL construction lenders will typically require an additional construction fee to compensate them for additional project risk.
Letter of Credit Requirements: We previously mentioned that the lenders may require a letter of credit from a bank or financial institution. This letter of credit is usually structured as 101% of the loan amount. Due to this, the issuer of the LOC will get the first lien on the property prior to construction completion, after which the lien will be assigned to the lender.
Pre-Required Rental Commencement: In this scenario, the lease requires that rental payments begin on a certain date, even if a Certificate of Occupancy (CO) has not yet been issued, or the tenant does not yet occupy the building. This may require the tenant to pay advance rent prior to occupancy. As previously mentioned, a surety bond will be required, which is assigned to the lender. A GMP (guaranteed maximum price) contract for the project contractor or contractors may also be required, which is also assigned to the lender. In addition, a pre-approved construction monitoring firm will oversee the construction loan draw process and regularly reviews the third-party engineering and inspection reports.
Credit Tenant Leases and Sale-Leasebacks
In some scenarios, a potential credit tenant who already owns the property may decide to sell it to free up additional capital for their business or pay off existing debts. However, they may want to keep operating out of that location for some time. This is where a sale-leaseback agreement may come in handy.
A sale-leaseback is when a large business that owns a property sells it to an investor with the stipulation that they will be provided a long-term lease at a set rate. For instance, a national grocery store that owns their store outright may decide to sell it to an investor on the provision that they get a 15-year lease with the set, graduated annual lease increases that don’t exceed 2% per year. If the seller, in this case, the grocery store, has the credit rating to qualify as a credit tenant, the new owner may qualify for credit tenant lease financing.
Loans With Covenants and Letters of Credit
Many CTL loans may contain a loan covenant. In this type of loan, the credit tenant agrees to maintain a certain level of financial performance, often measured by the debt-to-equity ratio or interest coverage ratio.
If the tenant (and therefore, the borrower) fails to meet these covenants, the lender can call the loan due and payable immediately. Breaching CTL loan covenants could also make a non-recourse loan into a full-recourse financial instrument, leaving the borrower (and perhaps the tenant) personally liable for making the lender whole
Letters of credit may also be required in some CTL lease/loan situations. In this case, the tenant provides the landlord with a letter of credit from a bank or other financial institution. The letter of credit guarantees that the tenant will make the lender whole regardless of the income generated by the specific property being financed.
Credit Tenant Lease Bond Investors
In many cases, a CTL lender will sell their loan, in the form of a bond, to one or more private investors. This allows them to reduce the risk of keeping the loan on their books, profit from bond sale fees, and free up more capital to issue additional loans. In this case, the Iender may attempt to convert a traditional NNN lease into a synthetic bondable lease, as we’ll discuss in the next section.
Synthetic Bond Leases, Specialty Insurance, and Credit Tenant Loans
To convert their loan into a bond, a CTL lender may purchase a specialty insurance product that protects the lender against lease termination. This can help them in the process of creating a new form of lease, referred to as a “synthetic bondable lease.” This allows the lender to record these loans as bonds on the company books. However, if a loan is legally termed a bond, the CTL loan may only be able to be issued at 75% LTV, though this various based on individual scenarios. Other CTL loan benefits, such as low interest rates and non-recourse loan provisions, however, will still remain.
Credit Tenant Leases and Residual Value Insurance for Increased Leverage
To increase the LTV ratio of a CTL loan, a borrower and lender may agree to purchase residual value insurance (RVI). This can turn the previously fully-amortizing loan into a balloon loan with a small balloon balance. The owner will typically plan to sell or refinance the property to pay off the balloon loan, but if this does not occur, the residual value insurance policy will pay off the remaining loan balance. Typically, this insurance policy will not cover more than 25% of the going-in value of the property, which the insurance company may be able to take possession of in order to make them whole.
Credit Tenant Leases and Multifamily Financing
Despite the usefulness of credit tenant leases, these leases (and their accompanying financing options) are not available for multifamily properties. The reason for this is that lenders view multifamily properties as riskier than single-tenant commercial properties.
Lenders believe that there is a greater chance that tenants will default on their loans due to the fact that multifamily properties contain tens, if not hundreds of tenants, with different credit scores and default risks, and each tenant is typically on a 1-year lease. This means that multifamily property vacancy and occupancy rates can vary significantly from year-to-year based on market conditions and other factors.
For highly qualified multifamily borrowers, great CTL financing alternatives can include HUD multifamily loans, Fannie Mae and Freddie Mac multifamily loans, and life insurance loans.
The Top CTL Loan Lenders and Advisors
Some of the top credit tenant lease lenders and loan brokers on the market today include:
Quad Capital: Quad Capital is a structured finance and real estate investment advisory services firm that serves the needs of borrowers, mortgage bankers, corporations, governments, governmental agencies, and institutional investors for credit-based and project finance transactions. They provide permanent CTL financing, CTL construction financing, and Government Services Administration (GSA) financing and bond placements. CTL is led by Managing Director and Principal Charlie Knudsen.
CTL Capital: CTL Capital prides itself on being a leader in structured lease finance. The company, which was founded in 1998, has completed over $14 billion in net lease financing, including $6 billion of direct loans and more than $1.2 billion of brokered loans. They have provided CTL financing to tenants in 30 states and 6 countries. CTL Captial is led by CEO Thomas P. Zarrilli.
Mesirow: Mesirow is a diversified financial services company that offers a wide variety of debt and structured finance products, including CTL loans. It also provides investment management, wealth management, and investment banking services. Mesirow was founded in 1937 by Norman Mesirow. Mesirow is led by CEO Richard S. Price.
Cafferty and Company: Cafferty and Company is a commercial real estate debt advisory firm with a specialization in credit tenant lease financing and life insurance company loans. The firm was founded in 2000 by CEO Mike Caffrey, and also provides advisory services for multifamily borrowers, with a focus on HUD/FHA, Fannie Mae, Freddie Mac, and CMBS loans.
Select Commercial: Select Commercial Funding LLC is a diversified commercial real estate loan brokerage that provides financing for a wide array of commercial properties, with an emphasis on both multifamily and retail NNN lease-based CTL loans. Select Commercial is led by Founder and President Stephen A. Sobin.
Grandbridge Real Estate Capital: Grandbridge specializes in commercial and multifamily real estate capital markets financing, servicing loan portfolios, providing asset and portfolio management, and real estate brokerage services. Grandbrige is led by Chairman of the Board and CEO Matt Rocco.
In Conclusion: Credit Tenant Leases Can Be Beneficial for All Parties
CTLs can be an attractive option for both landlords, tenants, and lenders. Landlords benefit from having a reliable source of income as well as getting excellent rates and terms on their loan, tenants can lock in an attractive, long-term lease, and lenders can sleep safe knowing that the borrower they've just lent money to is highly unlikely to default on their loan.