Lease Enhancement

Casualty and Condemnation Insurance

Credit Tenant Transactions

There is a specialty product in commercial real estate lending known as a “Credit Tenant Loan” (CTL). The common characteristics of credit tenant transactions are:

• A mortgage loan is made on a single-tenanted free-standing building
• The property is leased by a tenant that is investment grade rated
• The lease is triple-net or bondable, meaning that the tenant is responsible for maintenance, taxes, insurance, etc.
• The owner of the property is a special purpose entity (SPE) with no other assets except the property
• Most or all of the rent is assigned by the owner (SPE) and paid directly to the lender in order to amortize the loan on the building
• Term of the lease is 15-20 years, and the rent is usually a fixed monthly payment for the term
• Term of the loan is usually concurrent with that of the lease

To a lender or investor, the cash flow thrown off by the rental payments due under this “credit tenant lease” can be seen as the risk equivalent of the senior unsubordinated debt obligations of the tenant. Since the tenant is investment grade, the loan on the property (which is being amortized by the assignment of the rent payments) is the debt equivalent of the corporate bonds which may be issued by the entity.

Thus, real estate loans made in a credit tenant structure can be pooled and securitized as investment grade debt, providing immense liquidity to this niche of the commercial real estate market.

Need for Insurance

Because the amortization of the loan is largely dependent on the cash flow thrown off by the lease, investors require that any early termination rights (“holes”) in the lease need to be eliminated or insured over. Within a triple-net lease, these holes are referred to as condemnation or casualty clauses. This insurance has come to be called by many names, including casualty/condemnation, special hazard, casualty gap, condemnation gap, lease enhancement, and loss of rents.