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By Glenn Fydenkevez – President, MasterPlan Capital LLC
There are two principle reasons to invest in commercial real estate; current income today, and capital appreciation over time. For real estate investors primarily concerned with income, triple net (NNN) real estate investing has proven to be a very attractive option.
Single Tenant NNN Investing
In the world of commercial real estate the initials “NNN” refer to the fact that a parcel of real estate is leased to a tenant on a “triple net” basis. In-short NNN owners have virtually no landlord responsibilities. They don’t have to plow the driveway when it snows, repair the roof if it leaks or fixed clogged toilets when visitors use too much TP. A NNN property owner’s only responsibility is to collect the rent and pay the mortgage; everything else is falls to the tenant.
Savvy real estate investors and Wall Street Investment bankers understand that owning NNN leased real estate is more closely related to fixed income investing than it is to traditional real estate investing. With this knowledge it’s a short hop to credit tenant lease (CTL) finance. Through the magic of investment banking, specialized CTL bankers turn NNN leases into bonds and turn those bonds into cash.
Credit Tenant Lease Finance (CTL)
The concept behind CTL is easy to understand even while the actual CTL process is quite intricate. First, mortgage specialists originate a commercial mortgage loan. Next, investment bankers create and issue private placement bonds that are directly secured by the NNN lease on the target property. Finally brokers and bond traders sell the bonds to institutional fixed income investors like insurance companies, commercial banks, trusts, and pension funds. The proceeds from the bond sale are used to fund the mortgage and go to the borrower at closing. The entire loan is administered by an independent trustee throughout the life of the deal.
The investors who buy CTL bonds depend on the income the bonds produce, and the bonds, in turn, depend on the income guaranteed by the NNN lease that stands behind it. It follows that the financial strength of the tenant is paramount. To qualify for CTL financing the tenant must be considered “investment grade”. Usually this means that they need a high credit rating from one of the major rating agencies. CTL finance companies generally require tenants to have a BBB- (or higher) rating from Standard & Poors or a Ba1 (or better) from Moody’s before they will underwrite a CTL loan.
CTL finance and NNN investing work together like they were made for each other because in-fact they were. CTL is not the only way to finance single tenant, NNN real estate but it is definitely the most synergetic.
CTL bankers make no restrictions on loan-to-value (LTV) or loan-to-cost (LTC) when deciding how much money they will lend against a particular lease. 100% financing and even cash out financing is realistically possible when buying, building or refinancing with CTL. Bankers only require that the rent collected covers the mortgage payment. Debt-service-coverage (DSCR) ratios are exceedingly low, ranging from 1.05x right down to 1x. There is no question that CTL offers the highest loan balances in the commercial mortgage industry. (high LTV / LTC, and cash-out refi are almost unheard of in the realm of institutional financing in today’s credit environment).
Fixed Rate, Long Term, Fully Amortized
The majority of CTL loans are fixed rate, self amortizing loans with a term “coterminous” with the term of the lease (The loan is paid off when the lease expires). Long term, fixed rate mortgages, while commonplace in residential finance, are rare indeed in the commercial property sector. Long, stable loans allow sponsors to budget for the long haul. Mortgage payments don’t change and there are no looming balloon payments to plan for. Plus investors avoid the expense and hassle of refinancing every 3, 5,7 or 10 years.
The primary security that backs a CTL loan is the monthly income that the NNN lease produces. CTL bankers will not require borrowers to personally signature guarantee each loan, nor will they aggressively pursue the borrower if the tenant defaults. CTL lending is based on the strength of the tenant and the structure of the lease, not the wherewithal of the landlord.
Virtually all CTL loans are assumable by a subsequent buyer for a small (usually 1%) fee. So, not only will an original owner never be forced to refinance but, if they decide to sell, they can offer their buyer the benefits of a CTL loan for less then the cost of a new mortgage.
We’ve said that CTL lending is highly specialized and intricate, and it is, but it is also standardized. If a deal meets CTL criteria, the funding can happen very quickly and very efficiently. CTL loans have been known to close, from-start-to-finish, in as little as 45 days and it is rare for a loan to take more than 60 days to underwrite, fund and close. NNN investors can go from decision to closing table in about a third of the time it takes to close a bank loan.
Income and Tax Planning
Income is the main reason individuals and institutions buy single tenant, NNN, credit tenant real estate, but it is by no means the sole reason. Sophisticated real estate professionals acquire NNN assets for other reasons as-well. Savvy investors use NNN to take advantage of the unique tax benefits that real estate can provide. By adjusting the amount of leverage they use they can manipulate the amount of cash-flow a building produces and make the income and deprecation tax laws work for rather than against them. NNN is also often used as a vehicle for 1031 exchanges when investor’s desire continued income without having to manage a property or pay large capital gains taxes on a recent sale.
Construction and Development
Builders and developers like NNN real estate as-well, because they know they can stick to construction of a building without ever worrying about managing it. And with CTL financing readily available, they have the confidence that comes with knowing they can cash-out whenever they want.
One of the most attractive aspects of CTL finance is that it allows credit tenant property owners to execute cash-out refinance loans. As we mentioned above there are no LTV restrictions on CTL loans. If an investor bought right and has equity in a NNN asset, they can pull out up-to 100% of its value. Refinancing with a self amortizing CTL loan avoids all the fuss, bother, expense and time associated with selling, yet still allows owners to realize full value.
A Great Fit
For the sophisticated, income orientated real estate investor there is no better asset class than single tenant, investment grade, NNN real property. And for NNN investors there is no method of financing better suited to NNN than CTL.
About the Author: Glenn Fydenkevez is President of MasterPlan Capital LLC. He has over 20 years Wall Street experience and has been an officer at one of the worlds largest investment banks. About MasterPlan Capital LLC: MasterPlan Capital is a privately held commercial mortgage lender and real estate investment banking firm offering private and institutionally funded commercial mortgage loans, credit tenant lease (CTL) financing and other services to property owners and developers in the lower 48 states.
To get answers to your questions about CTL lending or other aspects of commercial real estate finance, call MasterPlan Capital at: 1-800-727-5140 xtn 101