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NAREIM Dialogues Fall 2017

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NAREIM DIALOGUES FALL 2017 35 For many, CTLs are uncharted territory. But, they do offer a smart way to solve debt challenges and remain financially solvent in both strong and uncertain markets. C L T MARKET TRENDS In a search to continually drive shareholder value, corporations are looking for ways to optimize their capital stack and monetize capital locked into non-revenue producing property, plant and equipment-related assets. CTLs enable corporations to unlock this capital through a long-term fixed-rate real estate loan at a cost of capital that is akin to their corporate borrowing rate. CTLs have become particularly popular with third-party investors seeking to retain asset ownership while paying off existing financing and recapturing owner's equity. Today, we're also seeing corporate and third-party owners using them as a source of high leverage construction-to- permanent financing for all asset types. IT'S ALL ABOUT THE ANALYTICS Take as an example, one private developer who was looking to procure construction-to-permanent financing for a 735,000-square foot headquarters facility to be built for Zurich in suburban Chicago. The borrower wanted a long-term source of fixed rate financing. Zurich, the tenant, wanted a state-of-the-art facility with low occupancy costs. Sounds tricky, right? With no obvious solution in sight, the notion of a CTL came up. There was one problem though – Zurich wanted its North American entity, Zurich American Insurance Company, to be the lessee and it does not carry a public rating. Because CTLs are heavily dependent on credit, many people think the conversation has to end there. Not so. After an intensive credit analysis based on the statutory financials Zurich posted, the answer became more apparent. From the analysis came a lease that maintained CTL eligibility for the developer, enabling it to achieve a low financing cost which, in turn, drove down Zurich's overall occupancy cost. The key is getting to the credit. You may have to go through several layers of corporate entities, but it can be done. You just need access to a provider of sophisticated real estate modeling and credit analysis capabilities. When you look at the Zurich example, the parent company is not on the hook. It was structured and funded as a $334 million construction-to-permanent financing at a relatively low fixed-rate for a 26-year term. That's just one example. Every deal is completely different. By their nature, CTLs offer the ability to customize a transaction structure for any given deal. Hartz Mountain Industries is a large, privately held real estate owner and developer that was looking to refinance the primary maintenance facility for the New Jersey Transit Corporation. The property was part of an industrial facility built in 1970 with three tenants, each holding an interest in the facility governed by a condominium regime. Conventional lending sources weren't bringing in the loan-to-value Hartz was hoping for. Digging deeper revealed an alternate, yet slightly unconventional path: restructure the condominium documents. Once that was done, it allowed for a full analysis of NJ Transit's credit as a tenant. Using a CTL enabled allowed Hartz to make use of the financial benefits of a highly credit-worthy municipal tenant and monetize the complex NJ Transit lease. Their CTL received strong interest from a number of global capital sources because of the strong credit rating, the modified condominium structure and the critical nature of the facility. That structure provided $48 million in proceeds at a low interest rate, which let Hartz finance tax-free nearly 96 percent of the market value of the real estate and re-deploy the capital elsewhere. DO YOUR HOMEWORK With an estimated $540 billion of capital sitting on the sidelines waiting to invest, get ready for an uptick in the number of companies asking questions about CTLs. On the investor side, there's a strong appetite for this type of paper – and for good reason. It's relatively safe. CTLs provide professional investors a predictable long-term cash flow stream that provides yields slightly higher than corresponding corporate bonds. Investment managers are grabbing a $150-200 million piece of these deals as the stable fixed returns provide a means of asset-liability matching. For many, CTLs are uncharted territory. But, they do offer a smart way to solve debt challenges and remain financially solvent in both strong and uncertain markets. ©iStock.com/spaxiax

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