Treasury Uncertainty? No Problem for Net-Lease Borrowers
- Feb 05, 2014
Over the past several months, Treasury rates have been searching to find their long-time trend. Influenced by a multitude of factors ranging from the incoming Fed Chair, strength in equities, lingering credit concerns in Europe, and new worries in China, the market has been up and down, nearing a breakthrough on its long-term trend.
For real estate investors, this uncertainty in credit markets has created a lot of suspense — for both sellers and buyers. Buyers are eager to engage in debt, if they perceive it at a rate as cheap as they will be able to get for some time, but are also cautious against taking shorter term loans that may leave them exposed to substantial re-financing risk if they feel long-term rates are truly poised for a long-term up-trend. Sellers, particularly developers, and short-term holders, looking to relieve themselves of property with in-place assumable debt, are foraging through buyers who think there may be better debt on the horizon than what has been originated in the past six to 12 months.
While much of the real estate lending market may be in flux, lending on net-lease remains, as it has been for some time — relatively predictable and easy to originate. Net-lease lending is targeted financing given to owners of real estate that is net-leased to a tenant (wherein a tenant pays all real estate taxes, insurance, and maintenance fees). This particular structure leaves a landlord with a “net” cash flow from the lease without any additional property- level expenses. Net-leased properties which are tenanted by a Credit-Tenant, therefore, are often viewed as a bond-like investment, especially given their generally long-term leases (10-25 years). With this type of lease/guarantee structure, lenders base their rates on a discount of the prevailing bond rate of the tenant plus an additional real estate risk premium, origination fee, and trading profit.
These particular loans are not dependent on future pro-formas or re-leasing expectations, but rather on pure cash flow derived from a credit-tenant, through a landlord with no operating expenses. Even within an environment of rising rates, these loans tend to stay more in line with the bond rate of the tenant rather than prevailing market rates.
Lenders are eager to provide financing for these types of properties due to their relative safety, historically high-performing percentage, and industry-leading minimal low rates of default. They tend to perform very well in higher- rated tranches of CMBS and are relatively easy to sell for originating lenders. We expect, as net-lease continues to expand and generate higher and higher volumes each year that this segment of real estate lending will continue to be in both high demand and supply, even amidst the uncertainty of treasury rates into the future.