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CRE Finance World Winter 2016
42
T
Securitization of Tenant
Improvement Loans
he financing of tenant improvements in meaningful
commercial properties has been an often overlooked,
yet potentially pivotal inducement property owners can
utilize, to attract or retain new or existing tenants with
regard to the commencement or renewal of significant
long-term leases. It would appear that this financing approach
has been bypassed, largely as a result of the dearth of applicable
information within the commercial real estate space, rather than
any conscious attempt on the part of property owners to avoid
such financing.
The cost of substantial tenant improvements, often exceed by a
very material amount, the allowance landlords are willing to offer
tenants. Consequently, the tenant is left to fund the balance, which
often can result in an undesirable or suboptimal use of capital.
Alternatively, the tenant may often be much more favorably positioned
to finance their share of tenant improvement costs, over the life of
the contemplated lease.
Be it commercial office, distribution center, retail, health care or other
substantial rental properties, the financing of tenant improvements
can be a decisive factor in enabling a commercial enterprise to
fulfill its business plans in connection with a strategic property.
Tenant Improvements Defined
Depending on the application of the property in question, the nature
of tenant improvements can vary dramatically, but in all cases, the
cost of such improvements involve significant interior modifications
and all related hard and soft expenses, such as demolition, debris
removal, framing, dry wall, electrical, plumbing, flooring, painting,
finishes, furniture, art work, IT hardware, architectural, engineering,
legal and accounting services. Moreover, such costs can go beyond
basic construction needs, and can include more sophisticated
mechanical, electrical and plumbing (“MEP”) services employed to
incorporate utility cost saving technology, which when compared
to additional financing costs, will generate even greater operating
cost savings. Examples of relevant tenant improvements can include,
but are certainly not limited, to the interior renovation of a corporate
headquarters, the retrofit of interior space into a major retail location,
the interior build-out related to a sprawling, fashionable urban food
court and the conversion of interior space to an in-patient health
care facility.
A typical tenant improvement project connected to a meaningful
commercial property can cost anywhere between $30-150mm, an
amount that can frequently be unappealing to fund with enterprise
equity. By contrast, the prospect of amortizing such costs over the
life of a long-term lease, can often be more attractive, from both a
financial and accounting perspective. Whatever the application, the
cost of needed tenant improvements can be a significant barrier to
an organization’s strategic plans, and the financing of such costs,
can provide the solution necessary to execute such plans.
Tenant Improvement Loan Structure
The basic structure associated with a tenant improvement financing
is characterized by a 10-20 year, fully amortizing, non-recourse
(absent bad-act carve outs) loan to a de novo special purpose
entity (“SPE Borrower”), secured by SPE Borrower’s claim to
unconditional, unencumbered and unabated payment obligations,
due and owing from the respective tenant or its guarantor (if
applicable). Such loans lack a mortgage on the underlying property,
and are effectively an unsecured obligation of the ultimate obligor,
passed-through to the lender by the SPE Borrower.
Like any typical unsecured loan, the debt service coverage ratio
(“DSCR”) with respect to the payment obligations secured, is
generally 1.0, and the loan to value (“LTV”) is typically 100%. Such
loans generally are voluntarily pre-payable, in lieu of a termination
subject to yield maintenance or defeasance, and a terminable
as a result of other limited events, at a 3 to 10% premium to par,
excepting termination due to condemnation or casualty, which
is terminable at par. Bad acts are indemnified by a de novo SPE,
either capitalized by a net worth of 10% of the outstanding loan
amount or guaranteed by up to no less than 10% of the outstanding
loan amount, by a credit worthy guarantor.
Given the structure described above, the creditworthiness of the
respective tenant or its guarantor (“Obligor”), is paramount to the
perceived credit quality of any such loan. Therefore, the rate ascribed
to such a loan is largely a function of spread attributable to the
Obligor, above the prevailing applicable risk free rate. Typically,
this translates into some reasonable illiquidity premium above the
credit spread corresponding to similar tenure, unsecured debt for
the respective Obligor.
Scott Sidell, Ph.D
Chief Executive Officer
First Sustainable, LLC
Chief Executive Officer
Compo Cove Capital, LLC