Credit Tenant Lease (“CTL”) Financing

By Brandon Wilhite

shutterstock_139661128At Metropolitan Capital Advisors (“MCA”), our clients’ financing requirements range from conservative low-leverage to more aggressive high-leverage and everything in between.  Due to their entrepreneurial mindsets, most of our clients lean towards higher leverage.

Perhaps the most aggressive financing structure (in terms of leverage) available to borrowers is Credit Tenant Lease (“CTL”) financing.  While most traditional financing structures emphasize the value of the real estate (the lenders’ collateral), CTL financing structures are based on the credit of the tenant and the structure of the lease with the real estate value being secondary.

Rather than a loan held on a bank’s balance sheet, a CTL loan is financed by issuing a bond against the income stream. The term of the loan is capped by the remaining primary lease term, and the loan is fully-amortizing (i.e. 20-year term with a 20-year amortization). The interest rate will be determined by the credit of the tenant.

Depending on the structure of the lease (NNN, NN, etc.) the lender will determine a constant Debt Service Coverage Ratio (“DSCR”), typically 1.00x to 1.10x, which will determine the loan amount that can be amortized over the term of the loan. CTL loans are not constrained by Loan-to-Value (“LTV”) or Loan-to-Cost (“LTC”), and depending on structure, they can often exceed 100% LTV/LTC.

What qualifies for CTL loans?

  • Investment Grade Credit – CTL financing is reserved for properties leased to tenants with investment grade credit as rated by one of the major ratings agencies such as Moody’s (Baa3 or higher) or Standard & Poor’s (BBB- or higher).

 

  • Lease Structure – The Net Operating Income available for debt service must be predictable within a thin margin.  Absolute NNN leases (i.e. zero landlord responsibility) can typically qualify for a CTL financing structure with 1.00x DSCR whereas NN leases in which the landlord is responsible for roof and structural repairs may only qualify for a 1.10x DSCR.

Additionally, leases with “outs” in which the tenant can terminate the lease or pay a reduced rent in the event that they do not produce a pre-determined sales figure (sometimes found in retail leases) or do not receive funding (sometimes found in government leases) may cause the property to not qualify for a CTL loan or significantly reduce the available loan proceeds.

  • Property Type – Typically any property type can qualify for a CTL loan. Typical property types include drug stores, grocery stores, offices, industrial, healthcare, government and education. As long as the rental revenue is guaranteed by an entity with investment grade credit and the lease is structured as described above, the property should qualify.

Any financing structure comes with trade-offs, and the tradeoffs for CTL loans generally focus on flexibility.  As mentioned above, similar to CMBS financing a CTL loan is not held on a lender’s balance sheet; rather, it is held by bondholders who purchased the bond with the expectation of an annual return for the life of the bond. Thus, the unamortized loan balance cannot be simply paid off at par before the maturity date of the bond (i.e. the end of the lease term). Any prepayment will be subject to Yield Maintenance to replicate the cash flows that would be realized by the bondholders if the loan had been held to maturity. The lack of prepayment flexibility makes assets financed with CTL loans considerably more difficult to sell or refinance, often prohibitively so.

Additionally, due to the structure of the financing in which the loan is sized to a 1.00x to 1.10x Debt Service Coverage Ratio, there is typically little to no cash flow available to the borrower after debt service. Instead, those cash flows are monetized upfront, thus requiring the borrower to make a smaller equity contribution or, in some cases, receiving cash at funding.

If you have a property that you believe may be a good fit for CTL financing, please contact me at bwilhite@metcapital.com or contact any of the Senior Directors at Metropolitan Capital Advisors.

 

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