For the first time, a major commercial real estate lender, Capital Lease Funding (CLF), based in New York, took its message promoting securitized credit lease financing on the road this spring through a series of seminars titled "Financing Properties Net Leased to Credit Tenants." The sessions were co-sponsored by NATIONAL REAL ESTATE INVESTOR and Shopping Center World magazines.
Informing audiences about the advantages and pitfalls inherent in financing such properties on Wall Street, the seminar provided attendees with detailed information on structuring transactions to take full advantage of the benefits of credit tenant net lease financing. Often among those benefits are tighter spreads on loans and significantly higher proceeds for borrowers.
Day-long seminars were held in May and June in Los Angeles, San Francisco, Dallas, Atlanta, Chicago, Philadelphia, and Boston.
Seminar highlights The Atlanta seminar was held at the Swissotel in Buckhead and featured presentations by a number of Capital Lease Funding (CLF) executives, including William Pollert, president and CEO; Paul McDowell, senior vice president and general counsel; and Edwin Glickman, executive vice president of product development. The program also included representatives of other industries involved in the financing process, including Duff & Phelps Credit Rating Co. and the law firm of Cadwalader, Wickersham & Taft.
Pollert explains that credit tenant net lease financing is becoming an important tool, but points out that the real estate industry needs to be educated on the advantages of this fledgling capital source.
The distinction between a traditional conduit CMBS real estate loan and credit lease financing is clear: In a conduit loan the lender's emphasis in on the real estate, whereas in a credit lease transaction the lender's emphasis is on the quality of the lease.
"What does the lease say? What ability does the tenant have to terminate the lease or abate rents? That is what drives a credit tenant lease," says Pollert. Historical perspective
Pollert explains that before 1995-96 the only credit tenant lease loans financed on Wall Street were bond leases in which the tenant has no lease termination or rent abatement rights whatsoever.
However, new programs are being introduced by lenders to allow the securitized financing of properties with triple-net and double-net tenant leases. These types of leases provide tenants with varying degrees of lease termination and rent abatement rights, or "holes" in the lease.
Such programs work by essentially creating and incorporating lease enhancements that, in essence, turn the triple-net and double-net leases into bond leases by eliminating the tenant's termination and rent abatement rights, or at least protecting the investor from such an occurrence.
As a result, the investor only has to worry about the credit of the tenant, which in CLF's case is always an investment-grade tenant (rated BBB- or higher). As you might assume, the default rate for investment-grade tenants is substantially lower than that of tenants with lower ratings. CLF completed the first such transaction in February 1997.
What about lower-credit or unrated tenants? According to CLF, it is also able to complete some credit-lease financing on properties with unrated tenants, although the terms may not be as attractive.
"Our programs include a variety of lease enhancement mechanisms to plug the real estate 'holes' in the existing leases," says Pollert. "We can now take properties with less than perfect leases, from Wall Street's point of view, and finance them through securitization."
The enhancements used include specialized, non-cancelable insurance policies to cover the risk of tenant termination or rent abatement, or the establishment of adequate reserves to cover landlord responsibilities such as structural repair and parking issues - items that could trigger the termination or rent-abatement provisions in a lease.
During the seminar, Pollert and company defined a number of "hot-button" lease provisions that owners should try to avoid due to the problems theycan cause in attempting a credit tenant lease financing transaction. Some of the se provisions include termination clauses tied to another tenant; environmental clauses; off-site/use exclusivity restrictions; substitution of like property; and highway construction/obstruction access.
"You don't want lease provisions that make allowances for things you cannot control such as another tenant or the government," explains McDowell.
The types of credit tenant lease programs created by lenders are still evolving. CLF recently created two new programs designed specifically for shopping center properties. But Pollert emphasizes that while retail is usually the property type associated with credit tenant financing, the scope is broader. "Almost any kind of property can be financed this way as long at there is a credit tenant and a decent lease."