Commercial real estate properties owned by a business that operates out of the buildings it owns are generally not eligible for CMBS loans. Financing related to these transactions is often referred to as “owner-occupied” loans and is often provided by commercial banks and the SBA with recourse to the business owners. However, mid-sized and larger companies can create a structure to be eligible for CMBS under certain circumstances.
ValueXpress recently underwrote a transaction for a building containing 40,000 square feet (sf) of office space and 360,000 sf of warehouse/distribution space that was purchased by a large book publisher in the Midwest. The building was to be used as an administrative office and distribution center. The building was larger than needed, so the publisher leased 40% of the space to a fortune 500 company for 15 years. The transaction was financed with a 65% loan with a local bank on a short-term, recourse basis payable on a 20-year amortization schedule. The publisher was not happy with the banker and sought a longer term loan on a non-recourse basis.
In order to make the 60% owner-occupancy level eligible for CMBS, the first test is determining the financial condition of the owner-occupant. ValueXpress obtained five years of audited financial statements that indicated sales in excess of $50 million per year and growing, and profits in excess of $5 million per year. Company debt, except that secured by the building purchase, was modest. Next, the terms of a “synthetic lease” were developed. Market rent was $7.00 NNN, so it was proposed that the company enter into a 25-year lease with the building entity (the company entity and building entity were separate) at $7.00 NNN or $1,540,000 per year. Adding back the existing mortgage payment on the loan being replaced, the company covered the rent payment over 4x.
With the two leases in place, the loan underwrote to a 65% LTV and an 11% debt yield, very good credit metrics and eligible for CMBS execution.