Despite the general economy showing some tepid signs of improvement, we remain in an extremely challenging credit market. Traditional lenders such as banks, Wall Street investment houses and insurance company conduits remain very timid about financing loans. They are concerned about their capitalization levels and the possible effects of the upcoming regulatory reform. In short, they are hesitant to close deals until some semblance of clarity returns to the debt markets.
Construction financing has been especially hard to come by during this credit crunch. All commercial real estate was overbuilt during the first 6 years of the decade and financial institutions are in no rush to add to existing inventory by financing construction deals. Lenders have avoided development loans for the last 24-36 months. Many, many good projects lie dormant due to illiquidity in the construction capital markets.
Amid all the pessimism, however, a segment of the commercial construction industry has bucked the trend. It turns out that there is plenty of capital available to build office buildings, retail stores, and even light industrial facilities, as long as the building in question is triple net (NNN) leased to a single “investment grade” tenant. (BBB- or better by S&P)
Financing NNN’s leased development is made possible by a special type of loan known as tenant credit lease (CTL) financing. CTL is a unique financing platform designed specifically to finance the purchase, refinancing and construction of commercial properties that are (or will be) occupied by a single tenant with good credit. CTL loans are underwritten based on the structure and length of the lease and the financial strength of the tenant rather than the underlying value of the building or the borrower’s credit. Unlike traditional lenders, CTL lenders count the lease and income it secures as the primary collateral that secures the loan.
CTL mortgages are originated by commercial real estate investment banking firms that underwrite and sell private placement mortgage bonds to finance the loans. The bonds are purchased by pension funds, endowment funds, insurance companies and other fixed-income institutional investors.
CTL loans tend to be long-term, fixed-rate, fully amortized commercial mortgages. Most CTL lenders do not place loan-to-value restrictions and will issue 100% LTV loans subject to a very low Debt Service Coverage Ratio (DSCR) of approximately 1.01-1.05. Also, there are no loan-to-cost (100% LTC) restrictions for construction deals. The result is the highest possible loan amounts for homeowners and developers.
CTL construction and development loans are true permanent construction financing; there is only one financing and only one closure. Mortgage payments are “interest only” while the building is being built and begin to be amortized only after the tenant moves out.
The most popular investment-grade tenants (and the easiest to finance with CTL) are US government agencies such as the US Postal Service, Social Security Administration, and the Department of Homeland Security. All government agencies have very good credit ratings because the Federal Government is supposed to support your debt. Developers building federal courthouses for the Department of Justice or administrative buildings for other government agencies will enjoy easy access to the funds they need.
Ample funds are also immediately available for private sector buildings, as long as the tenant is financially sound. Retail giant Wal-Mart qualifies for CTL loans along with The Home Depot and Kohl’s stores. Walgreens and CVS pharmacy chains are expanding rapidly and both are eligible for CTL financing. McDonald’s is the largest investment-grade lessee in the foodservice industry.
All commercial mortgage loans have been reduced during this economic downturn and recovery, while it may be underway, is many months away. During this time of turbulence in the credit markets, it is encouraging to know that some lenders are still negotiating and financing loans. CTL financing remains a dependent method of financing investments in buildings leased by NNN from a single tenant, including construction and development.