Fixed debt matched to the lease term, or short cheap debt with a balloon two years before expiry

Question

Take a 12 year net lease on a small format retail box, national tenant, $148k NOI, priced around a 6.9 cap so roughly $2.15m. Two financing paths are common in this situation, both worth confirming in writing before committing to either. Path one: ten year fixed, 25 year amortization, 60 percent proceeds. Debt matures with two years of lease term left, which means finding out what lenders think of a net lease box with 24 months of term remaining. Most net lease lenders size on remaining term and get uncomfortable inside five years, so a refinance at that point can mean a large paydown or a forced sale into whatever the market looks like that year. Path two: seven year fixed at roughly 40 basis points cheaper, same amortization, refinancing at year seven with five years of term left. Cheaper money, and the refinance window lands while the lease still looks attractive to a lender, but rate risk arrives three years earlier and a second set of closing costs comes with it. A third option exists: size the loan so it fully amortizes inside the lease term, take the lower proceeds, and never face a maturity conversation at all. Cash on cash drops meaningfully and the equity check rises by a couple hundred thousand. The case for path one is that ten years of certainty is worth more than 40 basis points. The case for path two is that refinancing while the collateral still shows well is the entire game. Reasonable operators land on both sides of this.

derekj19 · Answer

The thing I would want to know before picking is what the tenant does around year eight or nine, because that is what changes the refinance conversation more than the rate does.

If they exercise a renewal option early, or you can get them to sign an extension in exchange for something small, your remaining term at maturity goes from 24 months to something a lender will actually look at. I have heard of owners going to the tenant around year seven and offering a modest tenant improvement allowance or a small rent concession in exchange for pulling forward five extra years. Whether a corporate real estate department will engage with that depends entirely on how the store is performing.

So path one plus a plan to extend the lease before the balloon might be a different animal from path one on its own. Path one with no plan is you and a clock.

mitchell_ray4 · Answer

I build the tools rather than sit on the finance side, and the fully amortizing option is the only one where the answer does not depend on somebody else's mood in a year you cannot see. You said cash on cash drops meaningfully. By how much? If it is 7.5 down to 5.8 that is a real price to pay. If it is 7.5 down to 6.9 I would take the version with no maturity in it and go do something else with my week.

Rena Guide · Answer

The mechanism behind @luis_carrera's worry is worth stating plainly, since it catches people.

Net lease lenders generally underwrite the lease as much as the building. Remaining lease term at loan maturity is one of the things they look at, because if the loan comes due when the lease has almost run out, the lender is being asked to rely on a property that may be empty soon. Some lenders will not go past a term that leaves only a short tail. Others will lend, with lower proceeds or a required paydown. That approach differs by lender and changes with market conditions, so treat any specific threshold you hear as something to confirm in writing with the lender you are actually using, along with prepayment terms and whether the loan can be assumed by a buyer.

The reason the fully amortizing path removes the problem is that there is no balloon to refinance. You trade current cash flow for the removal of a future financing event. That is a preference, and reasonable people land in different places on it.

One detail worth pinning down on all three paths. Ask what happens under the loan documents if the tenant goes dark while continuing to pay rent, or if the lease is assigned. Some net lease loans include cash management or default triggers tied to the tenant rather than to your payment record. That clause can matter more than 40 basis points, and a real estate attorney should read it before you sign.

Fixed debt matched to the lease term, or short cheap debt with a balloon two years before expiry

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