Single Tenant Net Lease and the Utility of the Self-Liquidating Loan

January 26, 2017

Single tenant net lease properties are a common and preferred investment vehicle used to preserve wealth while maintaining a fixed stream of income over long periods of time. Many real estate investors who target single tenant net lease properties find security having long-term leases.  However, many of those same investors/owners do not take into consideration that the duration of their mortgage is an equally important variable that if properly structured can help mitigate risk.

For many investors in the single tenant net lease space, one of the biggest questions is, what should I do when my loan comes due with less than 10 years remaining on my lease?  Can I secure competitive long term fixed rate financing?

In many cases when a lease term has burned off below 10 years, the availability of securing competitive long term fixed rate financing diminishes.  Lenders are more selective when financing single tenant properties that have less than 10 years remaining on the lease term. Lenders that are willing to finance these properties usually structure the loan with recourse, provide lower leverage, shorter amortization and/or may require reserves or cash flow sweeps, in order to get comfortable with the short
duration of the lease.

I refer to this phenomenon in the net lease space as the “melting ice cube”.  Regardless of how well
located or strong your single tenant investment is, the remaining amount of time left on the lease directly impacts the property value and your ability to secure competitive long term financing.  As each year melts away on the lease term, the harder it is to secure longer-term competitive debt. It is understood that rental increases and other conditions over time may provide added value to your investment, but most single tenant leases tend to be flat or have nominal rent increases over the course of the primary term and often have challenges countering the negative impact of a shorter term lease.

Fully amortized financing is one of the best ways to insulate against this common issue. There are many competitive lenders who provide fixed rate fully amortizing loans from 10-30 years depending on the credit, lease term, and quality of the asset.  Please note that I am not speaking about CTL (Credit Tenant Lease) Bond financing which is a niche product typically reserved for investment grade tenants.

Life Insurance Company lenders thrive in this space. Many Life Insurance Companies have the ability to provide long term fixed rate products that match the duration of a tenants lease.  In most cases the lender does require the borrower to take a loan that is co-terminus with the lease term.  For example, if you have a 20 year lease term your loan would be fixed for 20 years and fully repaid when the lease expires.  This not only eliminates refinance risk, but in many cases creates additional wealth through the elimination of debt (this type of loan can amortize rapidly).

Whether you intend to sell or refinance, the shorter term your lease is, the more challenging it may be to execute on either strategy.  An investor’s goal should be to eliminate challenges as they approach the end of the lease term.  Self-liquidating financing is a tool used by single tenant net lease owners to manage lease maturity and mortgage balloon risk.