Developers Use Credit Tenant Lease Financing to Fund Construction of Single Tenant Buildings

Even as the general economy shows 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, are still being very coy about funding loans. They're worried about their capitalization levels and the possible effects of coming regulatory reform. In-short, they are hesitant to close deals until some semblance of clarity returns to the debt markets.

Construction financing has been particularly hard to come by during this credit squeeze. All commercial real estate was over built during the first 6 years of the decade and financial institutions are in no hurry to add to existing inventory by funding construction deals. Lenders have shunned development loans for the last 24-36 months. Many, many good projects sit dormant due to the lack of liquidity in the construction capital markets.

Among all the doom and gloom however, one segment of the commercial construction industry has been bucking the trend. It turns out there is plenty of capital available to build office buildings, retail outlets 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 leased development is possible because of a special type of lending known as credit tenant lease (CTL) financing. CTL is a unique funding platform designed specifically to fund the purchase, refinance and construction of commercial property that is (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 credit of the borrower. Unlike traditional lenders CTL lenders count the lease and the income it assures as the main collateral that secures the loan.

CTL mortgages are originated by commercial real estate investment banking firms who underwrite and sell private placement mortgage bonds in-order to fund the loans. The bonds are purchased by pension funds, endowments, insurance companies and other institutional fixed income investors.

CTL loans tend to be long-term, fixed rate fully amortized, commercial mortgages. Most CTL lenders place no restrictions on loan-to-value and will write loans to 100% LTV subject to a very low debt-service-coverage ratio (DSCR) of about 1.01-1.05. Likewise, there are no restrictions on loan-to-cost (100% LTC) for construction deals. The result is the highest possible loan amounts for property owners and developers.

CTL lending for construction and development is true construction-to-permanent financing; there is only one funding and only one closing. Mortgage payments are "interest only" while the building is going up and begin to amortize only after the tenant moves in.

The most popular investment grade tenant (and the easiest to finance with CTL) are US government agencies such as the US Postal Service, the Social Security Administration and the Department of Homeland Security. Government agencies all have very good credit ratings because it is assumed that the Federal Government will stand behind their debt. Developers building federal court houses for the Department of Justice or administrative buildings for other government agencies will enjoy easy access to the funds they need.

There are also ample funds immediately available for private sector buildings as-long-as the tenant is financially sound. The retail giant Wal-Mart qualifies for CTL lending along with The Home Depot and Kohl's stores. The drug store chains Walgreens and CVS are both expanding rapidly and are both eligible for CTL financing. McDonald's is the largest investment grade tenant in the food service industry.

All commercial mortgage lending has been curtailed during this economic downturn and the recovery, while it may be underway, is many months in the future. During this time of turmoil in the credit markets, it is encouraging to know that some lenders are still making deals and funding loans. CTL financing continues to be a dependable method of financing investments in single tenant, NNN leased buildings, including construction and development.