Credit Tenant Lease (CTL) Financing in Commercial Real Estate

Every landlord who’s held commercial real estate knows the value of a good tenant and understands that good tenants deserve incentives. One way that landlords can incentivize well-qualified tenants is with a credit tenant lease.

What is a Credit Tenant?

A credit tenant is a tenant that has a high credit rating, as determined by one of the major rating agencies (e.g. Moody’s or Standard & Poor’s). These tenants are financially stable and well-established, such as major corporations, well-known franchises, or government agencies.

The high credit ratings that these tenants have imply that they present a lower risk of default. Thus, they’re highly desirable tenants to have in a commercial property. Both landlords and lenders are exposed to reduced risk when leasing to a credit tenant.

What is CTL Financing?

CTL financing refers to a long-term loan secured by the income generated from a lease with a credit tenant. The loan is given to the landlord, and not the tenant, even though it’s based on the tenant’s rating.

The key feature of this financing is that the loan is primarily underwritten based on the strength and creditworthiness of the tenant, rather than the property itself. It also isn’t based as heavily on the landlord’s creditworthiness.

By basing financing on a tenant’s strong credit rating, lenders are often able to provide favorable terms on these loans. For example, CTL financing might offer higher loan-to-value ratios, longer amortization periods, and possibly even lower rates than what most commercial real estate loans provide.

Structures of Credit Tenant Lease in Commercial Real Estate

Credit tenant leases are normally structured as bond leases or triple-net leases (NNN leases), but also can be double-net leases (NN leases).

Bond leases leave the tenant responsible for all building costs. This not only includes repair and maintenance, taxes, and insurance, but they even must pay if the property is destroyed. The tenant takes on responsibility for restoring the property if it’s damaged in a natural disaster or other event. These are sometimes referred to as absolute net leases.

In a triple-net lease, the tenant accepts responsibility for most costs associated with the property, including taxes, insurance, and common area maintenance. This structure transfers most operating risk onto the tenant. NNN leases can usually be terminated in the event of a natural disaster, or if the property is partially destroyed in another event.

In a double-net lease, the tenant assumes most responsibility for property-related costs. The landlord may be responsible for some repair and maintenance costs, but certain repairs and maintenance can still be the tenant’s responsibility. Insurance and taxes remain the tenant’s responsibility.

Typical Terms for a CTL Loan

Specifics of CTL loans can vary, but most are favorable long-term loans. Typical specifics are:

Term: 10-25 years (or longer)
Interest Rate: Slightly lower rates
LTV: Maximum can be 90%+
DSCR Allowance: 1.00-1.05x
Amortization: Fully amortized
Prepayment Penalty: Yield maintenance

Most of these loans are fully non-recourse, except for standard “bad boy” carve-outs.

Pros and Cons of Credit Tenant Lease Financing

Credit tenant lease financing has multiple benefits, but it’s not right for every situation.

Credit Tenant Lease Financing Pros

Long loan terms, with many loans being for 10-15 years. Loans based on extremely well-established tenants might be for 25 years, or even longer.
Highly competitive interest rates that are likely lower than what could be attained if basing the loan on a property’s value.
Loan-to-value ratios of up to 90%+ are higher than what can be obtained via almost any other commercial property financing, including specialized loan programs.
Discount service coverage ratios as low as 1.00-1.05x virtually eliminate cash flow restrictions on what can be borrowed. Financing may be secured with no positive cash flow, if the tenant qualifies and the lease is an absolute net lease.
The long-term leases present a reduced downside for investors if rental rates drop.

Credit Tenant Lease Financing Cons

Credit tenants tend to be sole or anchor tenants. Should they break the lease and move out, repurposing such a large space can be expensive.
Closing times are often prolonged, and extensive documentation is required. The application and underwriting process are more involved since there’s another party providing the basis on which the financing is based.
Investors usually see low or no positive cash flow, which normally doesn’t allow for any distributions to be paid out. Returns are largely restricted to appreciation.
The long-term leases present reduced upside for investors if rental rates increase.
Tenants have reduced operational flexibility since they must sign long-term leases.

Credit Tenant Leases and Sale Leaseback

One of the most common situations where a credit tenant lease and CTL financing are used is in a sale leaseback. In a sale leaseback, the current property owner sells the property to an investor. The owner then becomes a long-term tenant in the property.

A sale leaseback allows the original owner to free up capital while maintaining occupancy of the property. For investors, the arrangement presents an opportunity to acquire a property without the associated cash flow expenses. It also lets investors secure a desirable credit tenant.

Wrapping Up

If you have a well-qualified and established tenant, signing a credit tenant lease could provide long-term stability and access to advantageous financing. You could also have the option of a sale leaseback if acquiring a new property. Talk with your tenant about the possibility, and see whether this isn’t a good solution for each party involved.