How Lenders Underwrite Single-tenant Permanent Loans

Tim Milazzo
September 21, 2018

Commercial real estate lenders typically underwrite a potential loan against a property by considering the rent and other revenue that it can generate, the expenses required to run it, and the overall track record of the owner (borrower). It certainly is more nuanced than that in reality, but it’s all about numbers that make sense and a strong borrower.

On a NNN leased property though, the underwriting goes a little bit differently. For those unfamiliar, NNN is shorthand for “triple net lease”, or a property where the tenant pays for essentially all of the expenses of the building in addition to paying rent. We already covered in a previous blog post how and why a borrower can get a very high LTC loan to build a new NNN leased property. Here we’ll examine where lenders focus their attention on providing a longer-term commercial mortgage on such a property.

Underwriting NNN real estate

Tenant’s financial strength

At the heart of the NNN arrangement, there is a commitment from the tenant to not only pay their rent for the duration of the lease term, but also to pay for repairs, real estate taxes, and most other expenses on the property. Analyzing that tenant’s ability to pay for it all, and avoid the likelihood of missing revenue, is paramount for the lender.

Most lenders will first look to see if the tenant is a public company or has issued bonds on the public market. If so, they should have a bond credit rating tracked by major rating agencies that can be relied upon as a measure of their ability to pay for the building through the lease term.

Length and characteristics of lease commitment

Next, a lender will want to know how long the tenant has committed to pay for the property, in addition to a few other things about the lease:

  • Is the landlord responsible for any aspect of the building’s upkeep?
  • Who is responsible for expected and unexpected repairs?
  • Does the tenant have an option to renew at the end of the lease term?
  • Are rent increases built into the initial lease term? Upon renewal?

Chance of renewal

The biggest change that a NNN property investment can undergo is a tenant leaving the property. In that case, to restore cash flow, the landlord will need to find a new tenant. A lender doesn’t want the property to sit vacant long enough to bankrupt the property and lose out on loan payments, so another variable the lender will look at is:

Value of the building without the tenant

If Dollar General is your NNN tenant and they decide to vacate the premises at the end of the lease term, you may be able to rent the same property to Family Dollar with adjustment to the structure. If the property is more specialized, or in a less desirable area for replacement tenants, reoccupying might take more effort. So the value of the property without regard to the current tenant is a downside risk that lenders must consider.

Who is underwriting these loans?

There are several national lenders, both banks and non-banks, with programs dedicated to the NNN lease real estate space. Some of them have precisely defined programs that will provide commercial mortgages on properties that house a particular list of tenants, while others are looking for a set of characteristics about the tenant, geographical market, and financials.

Local and regional banks are also often at play with properties within their footprints. Other regional bank lenders will follow locally-based borrowers out to outside markets where they are buying real estate. Some regional banks will do both, or only when the property and the borrower are both local. One of the big incentives for smaller banks is attracting more deposits, which is why many require the borrower to be within their local footprint, and they sometimes explicitly require opening and maintaining a banking relationship in addition to the loan product.

Calling on either a national or regional bank that does not have a specialized NNN product may not be successful, as it’s quite a different underwriting scenario than a typical multi-tenant commercial property.

A version of this work was originally published as a guest post on the Quantum Listing blog.

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