Connections for Success

 

03.05.15

Is a Credit Tenant Lease Right for Me?

Credit tenant lease (CTL) financing is gaining popularity as a way for owners and developers to leverage the rental stream from a single-tenant property. But, like most forms of financing, these arrangements have their risks and advantages.

How it Works

With CTL financing, rather than rely on the property’s value, the lender looks to the tenant’s creditworthiness and the cash flow from what is typically a long-term lease of 15 to 30 years. The lease is guaranteed by the tenant with no obligations for the landlord. The property owner assigns the rent payments to the lender, with the property pledged as collateral, and forms a special purpose entity (SPE) to hold the property and pass the rent to the lender.

CTL transactions are being used for a variety of properties including retail, grocery and drug stores; health care facilities; office buildings; warehouses; data centers; and bank branches. They are also becoming more common for government facilities and not-for-profit organizations.

These arrangements work well with triple net leases. In addition, double net and gross leases also might qualify with some expense and reserve deductions included for underwriting.

Appealing Features

CTL financing offers many appealing features, including:

  • Loan-to-value ratios as high as 100%;
  • No limits on loan dollars per square foot;
  • No maximum loan-to-cost;
  • Nonrecourse financing to the borrower;
  • Fixed interest rates; and
  • Amortization that can be linked to the lease term or structured for a longer duration or balloon payment.

Borrowers also may be able to use CTL transactions to offset passive income from other investments with passive losses (for example, real estate depreciation) if the arrangement has a 1.0 debt service coverage ratio, meaning all cash flow is applied to debt service.

Possible Downside

One possible downside for the borrower with CTL financing is the lender’s ability to preempt the right to restructure the loan in a Chapter 11 reorganization. Lenders generally require the involvement of an SPE in the arrangement to prevent it from being affected by a bankruptcy filing by or against the borrower.

In theory, a borrower will not be allowed to include the SPE’s assets and liabilities in a reorganization plan. But a savvy borrower may be able to take certain steps to circumvent a lender’s anti-bankruptcy provisions.

Optimal Terms

CTL arrangements can pay off for owners and developers that have the right type of property and lease. To ensure that you are getting the optimal terms to protect your interests, or for other questions, contact Anna Coldwell at  312.670.7444.

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