How does a lender mitigate the potential risk of the tenant vacating the property and still make a prudent loan?

July 15, 2021

Christopher R. Teeple

1. An office building has 100,000 sf of rentable space which is occupied by 10 tenants. The largest tenant has a lease expiring in two years with no options. The debt service coverage ratio on a new loan is 1.35x. If the tenant does not renew its lease, the debt service coverage ratio will drop to 1.05. The bank’s minimum requirement is 1.30x.
How does a lender mitigate the potential risk of the tenant vacating the property and still make a prudent loan?
2. Two side-by-side identical industrial buildings are leased to different tenants. One is leased to a national credit tenant for $12.00/sf for 20 years. The other is leased to a local company for $14.00/sf for 5 years with no options. The buildings are in a newly developed industrial park which is expected to be in demand in the coming years due to the expansion of the interstate.
Which building is worth more? Why?
3. You have received an application from a wealthy developer who is building a shopping center. The developer has built six similar centers in the past ten years and still retains ownership in three of them. You have no loans to this principal. Developer has interest from some tenants to occupy the space when it is completed, given this tenant-landlord relationship in other shopping centers. Your analysis of the deal makes sense to finance the loan but during your due diligence, you have found that an office building development that the principal built 12 years ago was foreclosed on by the lender. The lender lost money on the project. You discussed with the principal, who advised that the office market was soft at that time and when they completed it, tenants did not rent the property, which led to the foreclosure. It was also pointed out that it occurred a long time ago and on an office project – not a shopping center.
Do you proceed with the loan? Why? Or why not?
4. You are financing an office building for an existing borrower of the bank.
What are the first few steps you take in your initial analysis to decide if the loan is worth recommending to the loan committee?

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