There are 2 investment office types that the financing guide addresses:

• Single Tenant Office
• Multi-Tenant Office

A single tenant property is a commercial property that is leased to one tenant. A single tenant property can be leased to a local tenant, a credit tenant (publicly traded), or an institutional tenant (State of Florida, federal govt.). A national credit tenant is defined as a tenant with an investment-grade rating based on size and financial strength from a major credit rating agency such as Moody's and Standard & Poor's. For CCB’s underwriting purposes, an acceptable rating to qualify as a credit tenant is:

• Moody’s Baa3 or better or
• S & P BBB or better.

Leases executed by national credit tenants will typically have initial lease terms of10 years or more, are most oftentimes corporately guaranteed, and are triple net. Loans secured by building’s occupied by credit tenants are desirable loans for the Bank to originate, however, these loans are priced very aggressively and generate lower loan fee income for the Bank.

The added credit risks associated with single tenant office include: 

• Longer absorption periods to lease  due to a smaller tenant pool 
• If the office building were to go dark (vacant), there is no income being generated to offset operating expenses or the debt service requirements
• Typically significant costs are incurred if forced to convert the building from single tenant office space to multi-tenant space, and 
• If a property liquidation becomes the only source of repayment for the loan, then it becomes highly probable that the sale would be heavily discounted which could result in a loss to the Bank.

A multi-tenant property is a commercial property occupied by multiple tenants. The tenant base could include a combination of credit, local, and institutional tenants. Loans originated by the Bank that are secured by multi-tenant office space are more desirable loans for the Bank then loans secured by a single tenant occupied property.

• Class A 
  • Typically the newest and most state-of-the-art office buildings built of high-quality construction situated in great locations with top-notch management and lots of visual appeal. The buildings have high parking ratios, are energy efficient and feature the latest in HVAC, security, communication systems and best-in-class amenities (such as: cafes, beautiful lobbies, and valet service). Class A buildings are the most expensive from a rent per sq. ft. standpoint and are oftentimes occupied by banks, prestigious law firms, or institutional clients.
• Class B 
  • Office buildings fall in the age range from 10 - 20 years, have fair to good visual appeal, are somewhat well located, have a fair amount of on-site parking, functional HVAC systems, and adequate management. Many Class B buildings are 4 stories or less, but they can vary greatly in size. Class B buildings are occupied by mid-market clients, such as smaller local businesses. These buildings occupy the medium price range for rent per sq. ft..
• Class C 
  • Office buildings are typically 20 years or older, require renovations, have limited parking, are situated in less desirable locations, and have dated systems and limited amenities. These buildings are mostly occupied by small family businesses or new business owners looking for affordable rents. When underwriting Class C space, a lender will want to apply a 15-year amortization or less when calculating debt service and obtain a property inspection report.

An office tenant typically executes one of 4 types of leases. Below is a description of each type for review.

• Gross Lease - A gross lease is an agreement that requires the tenant (lessee) to pay the property owner (lessor) a flat rental fee in exchange for the exclusive use of the property. The fee includes all the costs associated with property ownership, including taxes, insurance, utilities, and building maintenance. A gross lease is oftentimes used when leasing single tenant office, industrial, and retail space.
• Modified Gross Lease - A modified gross lease is an agreement where the tenant pays base rent at the lease's inception, but the tenant takes on a proportional share of some of the other costs associated with the property, such as property taxes, insurance, utilities, and maintenance. This type of lease is most often used when leasing multi-tenant office and retail.
• Net Leases (3 types) - A net lease refers to a contractual agreement where a lessee pays a portion or all the taxes, insurance fees, and building maintenance costs. Oftentimes used in single and multi-tenant office and retail when national credit tenants occupy space within a commercial investment property.
  • Single (N) - In addition to rent and utilities, the tenant pays property taxes. All other expenses are paid by the property owner.
  • Double (NN) - In addition to rent and utilities, a NN lease requires the tenant to pay property taxes and insurance. The building maintenance is the responsibility of the property owner.
  • Triple (NNN) - In addition to rent and utilities, a NNN lease requires the tenant to pay all expenses associated with the property including property taxes, insurance, and building maintenance.
• Percentage Lease - A percentage lease is an agreement that requires the tenant to pay a base rent plus a percentage of any revenue (business) earned while doing business on the rental premises. It is uncommon to have percentage leases in the non-owner-occupied office sector.

A fifth lease type that a lender may encounter when financing commercial real estate is a ground lease. The simplest way to define a ground lease ownership structure, is 1 party retains ownership of the ground (lessor) and an investor/developer owns all of the improvements built and situated on the site (lessee). When the ground lease expires, the lessor not only retains ownership of the land but also the improvements. Ground leases will have longer terms (25 years plus). A lender should include the expense associated with the ground lease when calculating the properties debt coverage ratio. In addition, the remaining term of the ground lease should exceed the maturity date of the Bank’s loan.

Termination Clause(s) – When a lender is reviewing a lease, special attention needs to be given to determining whether the lease has a termination clause. A termination clause is a provision that will allow a tenant or lessee to terminate the lease before the maturity date of the initial term if certain conditions are met. A good example of a credit tenant who leases office space and requires that a termination clause be included in the lease is the State of Florida. Per Florida Statute255.2502, the State of Florida’s performance and obligation to pay on a lease is contingent upon an annual appropriation by the Florida Legislature.  For example: If your borrower leased an office building to the State of Florida for a term of 20 years, and in year 2 of the lease, the Fl. Legislature cut the appropriation for that particular lease expense, then per statute, the State has the right to terminate the lease without penalty if the following conditions are met:

1. Another state-owned building becomes available and the tenant (state agency) moves into that space and
2. The property owner (borrower) is given 6 months’ notice. 

Loans secured by properties where there is a long-term lease in place that includes a termination clause are considered undesirable loans to the Bank, especially on single tenant occupied buildings, due to the repayment risk the terms of the lease present for our borrower and the Bank.

Proximity to major highways, safe and desirable residential neighborhoods, quality schools, commercial businesses and retailers, and the availability of public transportation are important to the success of an office site. 

If the borrower is targeting tenant’s specializing in healthcare, the proximity to hospitals, doctor’s offices, and other healthcare providers is critical.

Both visibility and frontage are important in attracting quality tenants as visibility, frontage, and unobstructed signage are critical to achieving lease up and maintaining low vacancy rates. The walkability to your site and access to public transportation will have an impact on property performance especially if the property is located within a central business district.

A lender needs to evaluate the ease of getting to the site. Easy access is particularly important in areas experiencing major growth. Highly congested areas can be detrimental to the success of any commercial property. Traffic lights will help with the congestion and are preferred over curb cuts.

When evaluating the site, the lender needs to review the permitting reports published by the county and city to determine if any new road construction has been permitted near the site. The Department of Transportation (DOT) and other public authorities are continuously upgrading the road systems. A major road expansion or detour can have a negative impact on the tenants and the property’s operating performance. Inversely, road expansions or changes to traffic patterns can enhance a property’s location. Examples of this is the addition of a service road or a traffic light.

Verify legal access to the property through:

• Visual inspection, 
• Review of a survey, and 
• The review of title work.

The availability of public utilities to the site to include water, sewer, and electric.

A level site is more likely to provide for a higher amount of commercial density, lower costs related to stormwater management, and less drainage and flood concerns

Evaluate the site for potential environmental constraints or contamination. 

• A lender’s on-site inspection should look for potential wetlands (for example: standing water, low areas ,types of tree growth), dead vegetation, unidentifiable debris or abandoned equipment/ autos/tractors/fuel tank (operable or inoperable), homes or buildings, endangered species (for example: gopher turtles), indications of past use related to farming, dry-cleaning, manufacturing, railroads and processing facilities, waste dump sites, defense or military operations, and mines. 
• Read and review the Environmental Risk Management Policy in HelpU.

Drive around to identify any off-site properties within a 1-mile radius that could have the potential to contaminate or could have already contaminated the site you are considering financing. It is quite common for a property to become contaminated through the migration of contaminants from offsite properties.

Obtaining a Phase I Site Assessment performed by a qualified engineer will identify any potential Recognizable Environmental Conditions (REC’s).

If the property is located within a designated special flood area, evaluate the impacts that a weather event could have on your property’s cash flow, borrower, and collateral. Identify ways the Bank can mitigate its credit risk and decision the loan accordingly.

Within the state of Florida, our business clients are challenged by the constant turnover in insurance providers and rising insurance costs. A lender needs to understand what impacts there may be to a property’s cash flow if CCB has to place forced-placed insurance on the loan.

Confirm that your site has the appropriate zoning and future land use designation for the intended use. In addition, review the local permitting reports to determine if any new office sites have been permitted within your property’s defined market area which is typically a 3-mile radius or a 10 – 15 minute drive. This gives you an indication of the growth trends within the immediate area.

A lender should understand who the office project is targeting demographically and verify through CoStar that the submarket supports the borrower’s projections. Key demographic trends that a lender should review include:

• Change in number of households
• Population trends and forecasts (increasing or declining)
• Housing Prices and housing permits
• Employment trends (unemployment rate)
• Permits for office space
• Growth in the market from industries that have high demand for office space:
  • Government
  • Financial Services
  • Information Services
  • Professional Services and Business Services

If professionally managed, review the terms and conditions of the Management Agreement and integrate the related expenses in your cashflow projections. 

Research the management company, read client reviews online, and note the company’s experience in managing office properties. 

The ability for the company to effectively manage the relationship with the tenants, rental rates, occupancy, and to employ sound property maintenance practices are critical to the property sustaining cash flow performance during the life of the loan.

If new construction, obtain a feasibility study to:

• Identify the competition; 
• Validate your borrower’s forecast for costs, rents, occupancy, operating expenses, and net operating income; and 
• Determine the stabilization period.

In reviewing the rent roll, the lender should confirm that none of the tenants are on month-to-month lease terms. If so, the space will be considered vacant when underwriting the net operating income (NOI).

• An acceptable rent roll should include:
  • The tenant’s name, 
  • Unit number, 
  • Amount of leased space, 
  • Date of tenancy, 
  • Lease maturity date, 
  • Renewal options, 
  • Rental rate, and 
  • The common area expense maintenance requirements (CAM). Oftentimes CAM, property tax, and insurance expenses are stated on a per sq. ft. basis when leasing office space. 
• Lease rates will vary. The lease rate for occupying first floor space is going to be higher, especially if the building is multi-stories and there are no elevators. The lease rate for similar typed space should be consistent throughout the building assuming the lease maturity dates and terms are similar.
• Above market rents should be allowed only for triple net leases to credit tenants having at least 10 years remaining on the lease agreements without the consideration of renewal options.
• A lender should pay special attention to the initial date of tenancy and the maturity date of the leases. The Bank minimizes its credit risk when its collateral has a stable tenant base with longer termed leases in place. If a large percentage of the leases have a short-term expiration, the cash flow position of the property in the near future could change considerably. A rent roll with staggered maturity dates is more desirable. 
  • Note: If new construction, a minimum of 50% of the space should be preleased if not more prior to loan closing.
• The tenant mix is very important when reviewing a rent roll. A property with a good tenant mix is important in keeping vacancy rates low for office buildings. Sharing space with tenants that complement each other’s businesses drives higher revenues. For example: Law offices are often located within close proximity to realtors, or lobbyists within close proximity to legislators or the capitol. 
• Other points of interest in evaluating the rent roll should include:
  • Is there too much space occupied by one tenant type?
  • What is the impact of the tenant mix on parking? Consider the consumer peak time for your larger tenants.
• A lender should review each of the leases to confirm that there is no lease condition included that could negatively impact the rentability/marketability of the property. Also, confirm that the lease terms are consistent with what has been provided in the rent roll, paying particular attention to the lease rate(s), maturity dates, options to renew, termination clauses, and CAM requirements.

FS - Full-Service Lease or gross lease

If financing a Class B or Class C property older than 15 years, the lender should require a property inspection report especially if deferred maintenance items are noted during the lenders site visit.

When financing office construction or an office renovation, a lender should understand who is responsible for the costs for improvements to tenant space. If the office is preleased and the tenant is responsible for the TI costs, then the Bank will want to collect the TI money at closing and include in it the Loans in Process Account (LIP). The process is the same if the property owner is responsible for the TI.

Typically your other income on an operating statement for an office investment property would be related to parking or percentage rent income if the lease calls for percentage rents.

On an existing property, the borrower’s annual financial statements and tax returns for the last 3 years give a lender the most insight into the operating expenses associated with a stabilized office property. For new construction, the Bank relies on industry standards, the borrower’s proforma, the lease, the feasibility study, and the appraisal in estimating the operating expenses.

 The OER is the total operating expense divided by EGI. In your, Quick Reference Guide for Non-Owner-Occupied Properties, note that the typical operating expense ratio for office properties is as follows:

• Single Tenant Office: 32% - 40%
• Multi-Tenant Office: 35% - 45%

A newer property will scale toward the lower end of the range once stabilized and an older property, the higher end.

The lender is required to perform a cash flow analysis prior to presenting a non-owner occupied office financing request to Preflight or Credit Administration for confirmation that the requested loan amount is supportable based on the Bank’s underwriting criteria. Templates for cash flow analysis are available in the Quick Reference Guide. Below are detailed examples of cash flow analysis’s on both a single tenant office property and a multi-tenant office property. 

For CCB underwriting purposes, the reimbursements (for example: property taxes, insurance, and common area maintenance expenses) paid by the tenants to the property owner should be reflected on the revenue side in aggregate followed up by an itemization of the operating expenses as depicted in the previous accordion.

• Assess the site contractor's experience in building similar property types of the same scale
• Obtain an active contractor's license
• Determine if the contractor is bondable
• Obtain financial information if required as a condition of the loan approval
• Review contractor's website and request a resume of projects
• Collect and review the general contractor's (GC) liability insurance policy

From time to time the lender or Credit Administration require the borrower to fund an interest reserve at closing. An interest reserve account is a credit enhancement considering the construction project is not income producing while under construction or in lease up.

The interest costs during construction are funded from the Bank controlled interest reserve account by Construction Loan Administration (CLA) as the interest comes due. Interest reserves are non-interest-bearing accounts. The underwriting conditions that typically trigger an interest reserve requirement are:

• Low liquidity levels of the borrower,
• An extended timeline for project completion,
• Project size or type, or 
• Volatile conditions within the economy.