Lender wants 60% preleased, anchor tenant won't sign until permits are issued

Question

42,000 sf medical office building, all in at roughly $16.8M, so about $400/sf including a $85/sf TI allowance for the anchor. Construction loan quoted at 62 percent LTC, SOFR plus 325, 30 month term with an interest reserve. Condition precedent to the first draw is 60 percent preleased on executed leases. The anchor is a five physician orthopedic group taking 18,000 sf, which gets me to 43 percent by itself, and they've signed an LOI. Their counsel says they will not execute a lease until the building permit is issued, because they got burned on a project that never got approved. My permit is 7 to 9 months out and I'm paying to carry the land the whole time. Does an LOI ever satisfy a preleasing condition, and what structures do people use to break this deadlock without funding the whole predevelopment on equity?

Rena Expert · Accepted Answer

An LOI won't satisfy a preleasing condition anywhere I'm aware of. Construction lenders are underwriting a cash flow stream they can foreclose into, and a non-binding LOI gives them nothing to attach. What they'll accept is an executed lease with a defined commencement mechanism tied to delivery, rent commencing on a stated event, and a tenant credit they can evaluate.

The structure that usually resolves your specific deadlock is a lease executed now with a condition subsequent and a hard outside date. The tenant signs, and the lease terminates without penalty if the building permit isn't issued by a date certain, say 12 months out. Lenders vary on whether they count that toward preleasing, and many will if the outside date sits comfortably inside their own timeline and the termination right is narrow rather than a general out. Get that in writing from the lender before you spend legal fees drafting it. The tenant gets its protection, you get a countable lease.

Your $85/sf TI is the number I'd worry about more than the preleasing. That's $1.53M on the anchor space alone, nine percent of total cost, and medical fit-out routinely exceeds allowances once you're into medical gas, extra plumbing chases, and lead-lined imaging rooms. Confirm whether the lender is including TI in the loan budget and whether it counts in the LTC denominator, because if TI sits inside 62 percent LTC your real equity requirement on the shell is higher than it looks.

The other exposure is the reserve. At SOFR plus 325 over 30 months, the interest reserve was sized off a forward curve someone chose. If rates hold higher than that curve, the reserve depletes before stabilization and you fund the shortfall out of pocket, which is typically a covenant obligation rather than a choice. Ask for the reserve sizing assumptions in writing.

And underwrite the guarantee behind the anchor. A five physician group is not a health system. If the lease isn't guaranteed by the individual physicians or backed by something with a balance sheet, the lender may discount that 18,000 feet regardless of what the document says.

tashaford30 · Answer

Why won't the lender count the LOI if it names the tenant, the square footage, and the rent? I've always assumed a letter of intent was a real document. Is it just that it says non-binding at the bottom?

ehernandez74 · Answer

The outside date is the part I'd negotiate hardest and slowest. If the permit slips to month 13 on a 12 month outside date, the tenant is free and you're holding a permitted building with no anchor and a loan condition you can no longer meet. Twelve months on a 7 to 9 month permit estimate is not much cushion in a jurisdiction that takes three review rounds. I'd want either 15 months or an extension mechanism the tenant can't refuse unreasonably.

kevin_lombard · Answer

What is TI short for here, tenant improvement? And is the allowance money the landlord spends, or a credit against rent?

brandonlee36 · Answer

42,000 times $85 is $3.57M if that allowance applies building-wide, and even at just the anchor's 18,000 it's $1.53M on a $16.8M budget. That's the line I'd stress test before the preleasing question. Every medical fit-out I've watched from a distance ran over on mechanical, because the exhaust and makeup air for procedure rooms isn't what a shell was designed to carry. If you have to upsize rooftop units after the shell is priced, that's a change order at the worst possible moment.

karen_whitfield · Answer

Different angle on the carry. Rather than paying to hold the land through a 9 month permit, could you keep it under a purchase option with extension payments and only close at permit issuance? You'd pay for the option and lose it if the approval dies, and the option payments are usually a fraction of debt service plus taxes on a closed parcel. That doesn't solve the preleasing condition, but it makes the deadlock cheaper to sit in.

samantha_ruiz · Answer

@compass I've seen lenders count a lease with a permitting contingency, and the thing they focused on was how narrow the out was. General "tenant may terminate if not satisfied" language got rejected. A single objective trigger with a date got accepted. Worth having your counsel draft it tight before you show it to the bank, because once they read a loose version you don't get to un-ring that.

paulgrant17 · Answer

If the lease isn't personally guaranteed by the five physicians, what actually happens when two of them leave the practice? The entity signing the lease could be most of the value walking out the door.

omar_haddad · Answer

Lead-lined walls and floor drains are where medical TI budgets go to die. An orthopedic group with imaging in suite means shielding design signed off by a physicist, and the shielding drawings show up after the shell permit. On the renovation side I've learned to price the scope I can't see yet at the top of the range, and $85 a foot for orthopedic with imaging feels like the middle of the range, not the top.

gregpowell66 · Answer

Check your parking before anything else. Medical office typically underwrites at 5 stalls per 1,000 feet, so 42,000 feet is 210 stalls. Surface parking at 350 to 400 square feet per stall including drive aisles is roughly 1.8 acres of pavement for parking alone, and surface stalls have been running several thousand dollars each. If your site can't hold 210 and you end up in a deck, your $400/sf is gone. Does the $16.8M include the parking field at 5 per 1,000 or at a lower ratio someone assumed?

ryanmck27 · Answer

Commission on an 18,000 foot medical lease over a 12 year term is a large number paid at execution, and if the tenant has a rep you're paying both sides. Worth knowing whether that's in your soft costs or coming out of your pocket at exactly the moment you're also funding predevelopment. It's the kind of line that gets left off a budget because it doesn't feel like construction.

Lender wants 60% preleased, anchor tenant won't sign until permits are issued

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