CMBS' loss seems to be the credit tenant lease (CTL) market’s gain. The latter has shown robust growth in the face of the financial crisis and in its aftermath, mainly owing to the shutdown of the CMBS and conduit markets.

“The stars have been in alignment, and we did noticed that the CTL market was picking up steam in 2009,” said Michael Kalt, managing director and head of William Blair’s CTL group. The CTL market provides financing for investment-grade, single-tenant commercial real estate, where the loan is secured based on the underlying lease and the financed property.

These issuers, which normally would have turned to the CMBS and conduit markets, were left with limited options when the real estate bubble burst. The CTL market has also started to offer relatively attractive spreads and has become a more common form of funding than MBS, said Benjamin Harris, managing director and head of domestic investments at C.P. Carey.

Retail credit/tenants such as Walgreens, Home Depot, Lowes and CVS have participated in CTL deals. In June, alcoholic beverage company Diageo was involved in a $269 million deal, wherein a public REIT purchased a portfolio of vineyards from Diageo in a sale and leaseback and financed this with proceeds from a CTL transaction, Harris said. Federal, state and local governments, and not-for-profit health-care organizations have been getting more active in this market as well, Kalt added.

And the CTL market continues to flourish, because the other forms of financing it would normally compete against have yet to fully bounce back from the financial crisis. In addition to the CMBS market, banks and life insurance companies used to lend to these credit/tenants, but those forms of lending have yet to return to peak levels. Mortgage REITs also continue to suffer. Additionally, some specialty companies that were players in the CTL space have exited. GE Capital is one such example.

Holders of CTL paper also have some benefits over other securities, some say. “It is my argument that CTLs can be better than senior secured notes. Two years ago when liquidity evaporated it didn’t matter what you owned,” said Thomas Sargent, managing partner at Bostonia Global Securities. Furthermore, in the case of a bankruptcy, CTL paper often holds up better compared with senior unsecured notes, he added.

Kalt agreed, saying from an investor’s perspective a CTL investment allows for exposure to credit but still gives a secured interest in real estate. However, they also offer a lower debt service coverage ratios and from a liquidity perspective, CTL paper and plain vanilla private placements are about the same.

Furthermore, spreads on CTL deals are also attractive, sources agree. Yet, pricing one such transaction is not as simple as applying a constant spread over a comparable public bond issue, Kalt notes. In the CTL market, price boils down to industry, sector and credit, in addition to credit exposure on the buy side and the overall transaction structure. For instance, a healthcare 'AA' credit will be viewed differently from a government AA credit, or a corporate AA credit, he said. In the CTL market an NIAC-1 will not be price comparable across the spectrum of sectors.

Additionally, Harris said, pricing is driven by where the corporate bonds of a particular company are trading. These prices will also include an illiquidity premium of about 25 basis points or 50 basis points.

It is difficult to estimate the total volume of the CTL market because the deals are done through private placements, sources say. But they agree that issuance so far in 2010 has been higher than it was the year before. Sargent estimated issuance so far this year to be close to $3 billion. This market is always going to be small, primarily because the leases that get financed are long and “there is not a lot of long money out there,” he said. The transactions have maturities of about 15 years or more.

Since the market is small, there is a glut of certain names, which widens the spreads for these credits. Walgreens and CVS are two retailers that have a lot of CTL paper in the market, sources agreed.

Despite challenges like market saturation faced by some names, sources concur that the CTL market will continue to grow in the near term. Despite its credit sensitivity, this market is a good option for investment-grade issuers, especially while the conduit markets are still shaky. The signs of life in the CMBS market are visible, “But it’s not going to be like the go-go days of 2006-2007,” Kalt said.

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