Credit tenant lease (CTL) financing is a very efficient capital solution for the acquisition and refinance of single tenant, real estate that is net leased (NNN, NN or bondable) to an investment grade tenant.
Because CTL bankers don’t place restrictions on loan-to-value (100% LTV) CTL offers the highest loan balances in the commercial real estate finance industry, this makes CTL perfect for buyers who want to finance their purchases with long term, high leverage, fixed rate, fully amortized commercial mortgage loans, on a non-recourse basis. Likewise, CTL is the best method for pulling equity out of existing assets or refinancing older, high interest mortgages as they come due.
But, while CTL has proven itself in the purchase and refinance arena, many investors who build single buildings or develop large scale projects don’t realize that CTL loans are also available to finance assets being constructed from the ground up. As long as there is an executed, long-term net lease in place, and the tenant is credit worthy, CTL is a viable option.
Method 1; Standby Letter of Credit
Once a lease is signed a CTL banker can turn it into cash. Developers who want to use CTL to fund construction can do-so by utilizing a financial instrument known-as a standby letter of credit.
First the CTL banker originates, underwrites and fully funds a fixed rate, self amortizing commercial mortgage loan with terms that are coterminous with the lease. The loan amount can be just enough to cover construction or up to the full value (lease fee valuation) of the entire finished project.
The funds are deposited in a financially sound (rated A1 or higher) commercial bank (preferably one with offices near the project) and placed in certificates of deposit (CDs) with staggered maturities covering the estimated construction period. The Developer is credited with all interest that the CDs earn.
Next the bank, and the borrower, with the consent of the CTL Trustee, execute a standby letter of credit. This instrument protects the interests of all parties and will stay in place until the tenant begins to occupy the building and pay rent. The bank, for a small fee, administers the loan during construction, making distributions to the developer on a predetermined draw schedule. The builder makes interest only payments on the loan while the project is being built. The interest payments can be made using the deposited loan proceeds and are offset somewhat by the interest that is being earned by the CDs.
When the building is complete and the tenant moves in the standby letter of credit is dissolved and the loan begins to amortize. Any remaining loan proceeds are released to the developer and administration of the loan is transferred to the Trustee who will collect rent, pay the mortgage, and distribute any positive cash flow to the borrower.
Method 2; Forward Commitment
Forward Commitments are not to be confused with Letters of Intent (LOI) or Term Sheets; Forward Commitments are formal loan documents that are binding on all parties. Unlike a term sheet or LOI a Forward Commitment must be honored; if a builder delivers the building in accordance with the specifications within the time allotted the lender will fund and close.
Construction and development lending was the first type of financing to drop-off when the credit crisis hit and it will be the last kind of lending to recover. There are many things that can go wrong with a construction loan and nowadays the economy can change drastically in the 9-36 months it takes to build a quality building. These facts place development loans in the high risk category and bankers have shied away from them for the last 4 years.
The key to getting a construction loan is to take away as much risk as possible from the construction lender; and a Forward Commitment from a CTL banker is the perfect way to do it.
Banks give no credence to LOIs because they have no teeth. Any lender can back-out of any LOI at anytime. Experienced (Developers who have taken an LOI to a construction lender know this to be true.) A Forward Commitment, however, is a formal and legally binding permanent loan commitment to be closed when the building is finished. Banks recognize that Forward Commitments significantly mitigate the risk their capital is exposed to. Most banks will have no problem funding construction when they know that permanent financing is already in place; after all what do they have to lose.
Before a CTL banker will issue a Forward Commitment they will fully underwrite the project and verify the terms of the net lease. Again, the tenant must be investment grade and the building must be stand-alone and single tenant. The lease must be triple net (NNN), double net (NN) or bondable and should be at-least 10 years long. The CTL lender and the borrower will go through the entire CTL process up-to closing. The closing date will be based on the estimated construction time and should correspond with rent commencement.
With a Forward Commitment in-hand, a developer will have little problem securing construction from a bank or insurance company. They provide construction capital and the pre-negotiated CTL loan pays-off the bank loan and provides the long-term, fixed rate debt necessary to make the project viable.
Now Developers and Builders have two ways to use CTL finance to obtain construction money as-well-as permanent financing. They can take funds provided by CTL finance deposit them in a bank, and have the construction funded via a Standby Letter of Credit. Or, if they prefer, they can have the CTL banker issue a Forward Commitment and use that document as leverage in order to get a traditional construction loan.
Whether buying, refinancing or building, CTL lending remains an excellent capital solution for single tenant, net lease investors and developers.