Spencer Burton

Credit Tenant Lease (CTL)

A Credit Tenant Lease (CTL) is a specialized form of commercial real estate financing where a loan is provided for a property secured by a long-term lease (typically 10+ years) with a nationally recognized tenant boasting a high credit rating. This high-credit tenant often includes large national companies or government entities, generally with an investment grade credit rating (i.e. between AAA and BBB-). Due to the perceived security of these high-credit tenants, lenders tend to offer more favorable loan terms for CTLs.

Key Features of CTLs

  • Long-Term Leases: Usually spanning 10 years or more, providing stable, predictable income streams.
  • High Credit Tenants: Tenants typically include major corporations or government entities with high credit ratings.
  • Triple Net (NNN) Leases: Tenants are often responsible for most or all maintenance costs, taxes, and insurance, minimizing landlord responsibilities.
  • Double Net (NN) Leases: Occasionally, CTLs are structured as double net leases, where landlords share some maintenance responsibilities, potentially enhancing cash returns but increasing risk over time.
  • Coterminous Loans: The financing terms usually align with the lease duration, reducing refinancing risks.

Benefits of Credit Tenant Leases

  • High Loan-to-Value (LTV) Ratios: Can be as high as 95-100%, making it easier to secure substantial financing.
  • Favorable Debt Service Coverage Ratios (DSCR): Often between 1.00-1.05x, reflecting the high creditworthiness of the tenant.
  • Long-Term, Fixed-Rate Loans: Offering stability and predictability over the loan term, often up to 25 years or more.
  • Consistent Income: Reduced risk of vacancy and non-payment, providing reliable income streams for investors.
  • Non-Recourse Loans: Typically non-recourse, protecting the borrower from personal liability.
  • Lower Management Costs: Compared to multi-tenant properties, CTLs involve fewer management responsibilities.

Risks and Considerations

  • Last-Minute Loan Failures: CTL financings can sometimes fall apart due to securitization complexities and misunderstandings of rating requirements.
  • Spread Creep: Unexpected increases in spreads can occur, impacting the overall cost of financing.
  • Lease Enhancement Insurance: Some lenders may require this insurance, adding to the borrowing costs.
  • Specialized Knowledge Required: Borrowers generally must work with specialized CTL lenders given the complexities involved.

Sale-Leaseback Transactions

CTLs are often part of sale-leaseback transactions where an investor buys a property and leases it back to the seller at a set rate for an extended period. This allows the original owner to free up capital while continuing to occupy the property.

Putting ‘Credit Tenant Lease (CTL)’ in Context

Scenario Overview

Sunshine State Capital, a real estate investment firm specializing in core acquisition investments, is evaluating an opportunity to acquire Orlando Retail Plaza, a single-tenant retail property in suburban Orlando, Florida. The current owner, Golf Pro Live, a national recreational chain with a strong credit rating of A- from S&P, is seeking to execute a sale-leaseback transaction to free up capital for expansion.

Property and Lease Details

  • Property Name: Orlando Retail Plaza
  • Location: Suburban Orlando, Florida
  • Tenant: Golf Pro Live (A- credit rating)
  • Lease Type: Triple Net Lease (NNN)
  • Lease Term: 20 years
  • Annual Rent: $1,000,000
  • Rent Escalation: 2% per year

Financing the Acquisition

Given the tenant’s high credit rating and the long-term, triple net lease, Sunshine State Capital decides to utilize a Credit Tenant Lease (CTL) financing structure to fund the acquisition.

  • Purchase Price: $16,666,667
  • Loan Amount: $14,106,615
  • Loan Term: 20 years (coterminous with the lease)
  • Interest Rate: 5.00% fixed
  • Amortization Period: 25 years
  • Loan-to-Value (LTV) Ratio: 84.6%
  • Debt Service Coverage Ratio (DSCR): 1.05x

Key Benefits of CTL Financing

  • High Loan-to-Value (LTV) Ratio: With an LTV of 84.6%, Sunshine State Capital can finance a substantial portion of the acquisition cost, reducing the amount of equity needed.
  • Favorable Debt Service Coverage Ratio (DSCR): The DSCR of 1.05x reflects the tenant’s high creditworthiness, ensuring the property’s income can cover the debt service with a minimal buffer.
  • Long-Term, Fixed-Rate Loan: The 20-year fixed-rate loan aligns with the lease term, providing stability and predictability for Sunshine State Capital.
  • Non-Recourse Loan: The loan is non-recourse, protecting Sunshine State Capital from personal liability.
  • Consistent Income Stream: The long-term lease with a creditworthy tenant ensures a reliable and predictable income stream.

Risks and Considerations

  • Last-Minute Loan Failures: CTL financings can be complex and may fall apart due to securitization issues or misunderstandings of rating requirements. Sunshine State Capital mitigates this risk by working with a lender experienced in CTL transactions.
  • Spread Creep: Unexpected increases in financing spreads can impact the overall cost of the loan. By locking in a fixed interest rate, Sunshine State Capital minimizes this risk.
  • Lease Enhancement Insurance: Some lenders may require lease enhancement insurance, adding to borrowing costs. Sunshine State Capital includes this potential cost in their financial analysis.
  • Specialized Knowledge Required: Navigating CTL transactions requires expertise. Sunshine State Capital collaborates with specialized CTL advisors to ensure a smooth process.

Conclusion

The acquisition of Orlando Retail Plaza through a Credit Tenant Lease (CTL) financing structure allows Sunshine State Capital to secure favorable loan terms due to the high credit rating of the tenant and the long-term, triple net lease. This strategy provides Sunshine State Capital with stable, predictable income and minimizes management responsibilities, aligning with their core acquisition investment strategy.

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