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- Initial parameters
- Industry analysis
- Asset originator analysis
- Token issuer analysis
- Implementation details
- Proposed covenants
Tenant lease finance is a specific area within commercial real estate that is traditionally stable with clearly bounded risk parameters. The two main risks are interest rate and economic conditions. Interest rates are unlikely to increase in the short term and economic conditions, while hazardous to predict, are unlikely to impair too much the senior position of Maker if the investment is made with proper risk management.
Nevertheless, some risks are present in the collateral under study :
- There is possibly a conflict of interest as 6S Development (the main developer) and 6S Capital (the asset originator) are managed by the same people.
- The industry is also called Credit Tenant Lease but some of the tenants are not credit worthy according to notation agencies. This seems quite a deviation from industry standards. There is no constraint on credit quality and neither on concentration risks.
- The Trust scheme removes Maker from the actual decision process and sets a rigid contract that must be followed. The only power really left in Maker hands is the liquidation which is not practical and costly.
A solution was found between 6S and the risk team. It gives the Maker Representative all the due diligence information on every investment project a week before the credit line is drawn by LendCo. That will leave enough time to reduce the debt ceiling and avoid the transaction by letting a risk domain facilitator issue an executive vote. Nevertheless, it is expected that 6S Capital Partners managers and Maker Representatives will establish a more informal way of working.
Warning: For the sake of speed, and to move forward, this risk assessment has some limitations notably:
- No NDA was signed and no confidential information was exchanged, therefore due diligence on the stakeholders is limited, notably on their financial stability.
- This risk assessment focuses mainly on the tenant risk and is light on construction risk as this space is less documented. That doesn’t mean that there is no risk.
- Final contracts and details were not available at the time of the risk assessment (which is a prerequisite to finalize those). We made this risk assessment considering that the finals contracts correspond to the spirit, our understanding of the term sheet and the discussions.
Those are taken from MIP13c3-SP4 that was approved on chain.
Debt Ceiling: 15M
Stability Fees: 3%
Liquidation: See MIP21
The collateral under study (SIXS) is single-tenant commercial leases construction projects (some being finished).
6S Capital LLC is an asset originator in commercial real estate throughout the United States. The company is incorporated in the Delaware. It is specialized in Single-Tenant Net Lease. The managing director is Matthew V Rabinowitz, a Maker community member (@mrabino1). It “was born during the COVID-19 banking credit squeeze when its sister company, 6s Development LLC, had challenges with banks no longer wanting to provide credit.”
6S Capital Partners LLC is the SPV. It is managed by 6S Capital LLC. The senior tranche of the SPV will be subscribed by the Maker Protocol. The equity tranche is expected to be subscribed by external accredited investors.
6S Development LLC is expected to be the main project developer. It has been managed by Jordan Amyx since 2016. Previously to that, he was Real Estate Manager for Dollar general. Matthew Rabinowitz is exercising as CFO. He joined the company in 2016. The company was formed in Delaware.
Wilmington Trust will be the trustee defending the MakerDAO interest in the lending process.
- MIP21: Real World Assets - Off-Chain Asset Backed Lender
- MIP13c3-SP4 Declaration of Intent & Commercial Points - Off-Chain Asset Backed Lender to onboard Real World Assets as Collateral for a DAI loan
Provide an overview of the industry where the SPV assets will be, especially what are the risk, benchmark and historical behaviour. A market comparison with other lenders can be useful as well.
The overall industry is the single-tenant commercial lease business. The collateral under study is focused on the construction part and the initial lease (bridge). This industry enjoys long-term leases (10-20 years) and few expenses as the tenant pays directly for most of it. It is also called triple net as the tenant pays for property taxes, building insurance and most maintenance costs. The rent usually has an escalator part meaning that the rent is contractually increasing year after years (1-2%).
An example of single-tenant net lease contracts can be found here.
The value of a single tenant lease property tends to decrease with time. Indeed, the value of a property with a 20 year lease is higher than a similar property where only 10 years of lease remains. A vacant property is an expense (insurance, …) and might require a significant cost to be rented again (up to demolition and rebuilding).
Using this example, we can estimate that a property value can fall by as much as 43% between a 15-year lease rented property and a vacant one (before annual expenses to keep the property in good shape and commercial expenses to find a new tenant). This can happen quickly if the tenant defaults (which highlight the need of having good tenants). There can also be lease cancellation clauses.
Using the vacant discount discussed earlier and the Wawa cap rate profile from the Boulder Research report, can can deduct the following property value according to the duration of the lease left (the property value is based on a 20-year term lease).
The Boulder Group is providing research on the single tenant lease market. One main metric is the cap rate (annual rent / acquisition price) which is displayed in the graph below. It is at a low level mainly due to the fall in interest rates. If we focus on the beginning of the graph, we can see that the 2007 crisis impacted the market with a significant delay.
It makes sense to use the spread between the cap rate and the risk free rate to see what variation is due to a stress in the market. If we look at 2010 the spread with the 10-year government bond (the risk free rate, not displayed) was 460bps which is quite an increase from 250bps in 2007 (+210bps).
Currently the cap rate is around 6% for retail. Should this cap rate increase by 200bps, it would negatively impact the value of the asset by 25% (assuming the rent stays constant).
10-year bond Interest rates are expected to remain low for the foreseeable future, therefore the risk is small on this front.
This peer analysis section presents a comparison with other companies in the industry.
Realty Income is a $20B market cap company. It is one of the biggest owners of single-tenant commercial properties (triple net leases) in the USA. Texas is their main market with 11% of rental revenues (834 properties).
It is worth noting that the debt ratio (LTV or total debt / gross asset value) of Realty Income is only 38% at 2020Q2 (i.e. 62% of equity). This is a much lower level of debt compared to the collateral under evaluation which proposes having only 15% of equity against stabilized leases. The risk is an order of magnitude higher in the proposed collateral.
While not perfect this example allows us to understand the overall market. It contains mainly stabilized leases while the collateral under study has mainly construction projects. This, again, is more risk on for the proposed collateral.
The stock price (equity valuation) was hit by the Covid fear but the current price level is similar to 2017/2018.
The company was able to issue $600M of unsecured bonds in May 2020 at 3.25%, showing that the primary market is still open for such a business.
Looking at the secondary market, using the July 2024 maturity, we can see that after a small stress in March, the price is now at an all time high (higher price meaning a lower yield and a lower perceived risk).
In conclusion, this example shows that the industry is well rated by investors even in the middle of the Covid crisis.
As defined earlier, the quality of the tenant is of first importance for credit tenant lease as it influences the price of the property a lot.
The table below presents all tenants defined in the term sheet, their expected risk bucket, the rating from Moody where applicable and the average cap rate provided by Net Lease Advisor (the lower the less risky).
All leases are expected to be signed (or guaranteed by) the tenant declared in the term sheet and not a franchisee or a subsidiary.
|Tenant||Risk bucket||Moody rating||Avg. Cap rate|
|Dollar General||Very low||Baa2||6.75%|
|Service King||Very high||Caa3|
|Caliber Collision||Very high||B2-PD||6.43%|
|O’Reilly Auto Part||Medium||Baa1||5.54%|
|Dutch Brothers Coffee||Unknown|
|Brambles Companies||Very low||Baa1|
We also provide a more detailed discussion of each tenant.
Dollar General is a $50B public company. It operates 16,368 variety stores in 45 states.
Just looking at the share price, you can deduct that the company is in good shape. Indeed, revenue growth for 2020S1 is +25.9% (+20.2% same-store comparison). Cash flows from operation are great too.
S&P is rating the long term debt BBB which is investment grade (with one grade safety before junk). Moody rating is in line with Baa2.
This is a very low risk tenant.
Service King is a national automotive collision repair company. It is currently owned by Blackstone and Carlyle in a LBO from 2012 (and 2014 for Blackstone). The owners tried to sell the company in 2017 without success. In 2017, it had 312 locations in 23 states.
A Google Trends search on Service King shows a drop on traffic starting with Covid-19. People drive less and therefore have less repairs to be made.
Moody downgraded the company in August to Caa2-PD with a negative outlook (L12M of EBIT doesn’t cover interest costs) and a good amount of debt is due next year. The senior unsecured debt is rated Caa3. If the Google Trend data is indicative, we can assess that the situation is only getting worse before taking in account any possible lockdown.
Below you can find congestion data from TomTom which shows the same story.
This is a very high risk tenant as the company is likely to be bankrupt in the next year.
Caliber Collision is an auto body repair and paint shop with more than 1100 centers across 32 states.
Following the Covid-19 slowdown, it has reduced the rent payment by 40% to the landlords.
Again Google Trends data on “Caliber Collision” are not supportive of a recovery. There is no evidence that the rent is now paid fully neither.
Moody rating is B2-PD with negative review and some debt is already Caa1.
This is a very high risk tenant as it has already started to default on his rent.
Signature Collision is a collision repair business started in 2004. It has 20+ locations across the east US.
Few data has been collected on this tenant.
O’Reilly Auto Parts is an american auto parts retailer with 5,400 stores across 47 states. It is a publicly traded company member of the S&P500 with a $32B market cap.
A look at the share price shows that the market isn’t much concerned about O’Reilly prospects.
The company seems unaffected by Covid19 with sales and operating profit increasing.
One should still note that the liquidity position of O’reilly is not the safest. The current ratio (current liabilities minus current assets) is below 1 (but above 1 if considering the Credit revolving facility). Using the more restrictive quick ratio measure (which mainly removes inventories), the situation is even worse as most of the current assets are inventories.
Financial leverage is a trend for O’Reilly with a long term debt to equity ratio hitting 700% in 2020S1. Before 2014, it was never above 30% (the last highest ratio was 77% in 1998, ten times less than currently).
Moody still gives a Baa1 rating (but that was more than one year ago and Moody focuses mainly on debt/EBITDA metrics. S&P ranks the company as BBB (again with a focus only on earning related metrics).
Due to the financial leverage on the balance sheet side, this is a medium risk tenant.
Wawa manages more than 900 convenience stores and gas stations across the east coast. The company is privately owned so it is difficult to find more information. Nevertheless, according to anecdotal evidence (BBB rating from Fitch) and the very low cap rate asked by the market, we can put it under low risk.
A look at the share price shows a company profiting from Covid. Indeed, the 2020Q3 results are very good with a +31% sales (+27% on a comparable basis) and +56% in net income.
Financial metrics are with a current ratio above 1 and a long term debt to equity ratio of 25%. Moody rating is Baa1 which makes it investment grade.
This is a low risk tenant.
Grocery Outlet is a chain of 347 discount supermarkets. It is a $4B market cap publicly traded company.
A look at the share price shows a company in good shape. Indeed, 2020Q2 results were great with +24.5% sales growth (+16.7% on a comparable basis) and a healthy 7.5% adjusted EBITDA margin and 5% adjusted net income margin.
Financial metrics are healthy as well with a current ratio above 1.5 and a long term debt to equity ratio of 53%. The company is rated B1 by Moody which remains in the highly speculative area. Since, the ratings metrics have improved (as they are since the IPO). The poor rating is mainly due to the small size of the business and a more leveraged past.
This is a low risk tenant.
Dutch Brothers Coffee is a drive-through coffee chain with more than 347 locations. It is privately owned and no information was found.
Starbucks Coffee is an American multinational chain of coffeehouses. It is a $110B publicly traded company.
A look at the share price shows support from the stock market despite a -9% revenue growth from comparable stores. Net earnings for 2020Q4 (fiscal) are down 51% and 2020 fiscal full year are down 74%. The company expects a sharp increase for next year.
This is a low risk tenant.
7-Eleven is an international chain of convenience stores. It has 71,100 stores in 17 countries and is owned by Seven & I Holdings Co.
Moody recently placed the Baa1 rank under negative perspectives due to the acquisition of a competitor that will increase the debt burden. Nevertheless, there is strong support from the parent company (evidenced by equity infusion). S&P rating is AA-.
This is a very low risk tenant.
Amazon is a behemoth, profitable, rated A2 by Moody, A+ by Fitch and AA- by S&P and with a strong balance sheet.
This is a very low risk tenant.
FedEx is a multinational delivery services company. It is a $70B publicly traded company.
The share price of the company is quite unsure but feels quite supportive recently. The company had some “not so good” years in 2019 and 2020 (fiscal years) with losses in some quarters. Nevertheless, FY2021Q1 was very good
The yield on the 2046 maturity bond is decreasing, showing support from the bond market, with a yield to maturity of 3.2%.
This is a low risk tenant.
UPS is a multinational package delivery and supply chain management company. It is a $115B publicly traded company.
The stock price was quite flat those last years with a recent surge. There was some growth in 2020Q3 (+16% revenues, +11% operating profit, +12 net income).
The credit score is A- for S&P and A2 for Moody.
This is a very low risk tenant.
Brables is a public Australian company that specialises in the pooling of unit-load equipment, pallets, crates and containers
The stock price is moving sideways.
The company is rated Baa1 by Moody and BBB+ by S&P. Net debt/EBITDA is 1.1x and EBITDA/net finance costs is 19.3x. Current ratio is above 1, long term debt to equity is 64%. The management seems to pursue a more aggressive financial strategy but, so far, the financial leverage is still low.
This is a very low risk tenant.
To get a feeling of what can happen with a portfolio of credit tenant leases, here are some projections of a possible portfolio under some scenarios. It is limited to stabilized leases but we expect that construction risks are hard to model. If there is no construction issue, a construction project ends up as stabilized anyway.
This portfolio is diversified on the expected tenants. Currently, nothing enforces such diversification and the portfolio might end up concentrated on a few lowest quality tenants.
As we have seen, the value of a property is directly linked to the lease on it. The longer the remaining lease, the higher the value. So what happens if we move forward a portfolio 5 years in the future to account for the property value decay? We assume the cash flow of the period to be null (repaying the loan interests and recycling the exceeding capital elsewhere).
As you can see in the spreadsheet, going from a 20-year lease to a 15-year lease decreases the value of the assets by around 6% (as expected cap rate increases by 6%). Nevertheless, most leases have an indexation clause that increases the rent by 10% every 5 years. Therefore, all other things being equals, the portfolio has increased its value.
No issue here but one should remain attentive to the reindexation clause.
During a crisis, like 2008, the market might increase the expected cap rate by 2%. While this change remains minor, it decreases significantly the market value of the properties. This wipes out all the equity in the SPV (15% of the value as it is stabilized properties) and incurs a 14% loss on the debt.
This is only the mark-to-market evaluation and it doesn’t mean that there is any liquidity issue if the rents stay above the debt interest expenses. Nevertheless, liquidation is no longer an option in such cases.
For scenario 3, we use the same settings that scenario 2 but adding two properties that become vacants due a default from their tenants. Interestingly, this doesn’t change much from scenario 2 results (just a bit worse). Indeed, we keep the same 43% discount on vacant properties. Maybe we should expect more difficulties to sell a property without a tenant in the middle of a crisis.
We remain in the same issue as scenario 2 with no possibility to liquidate without a significant loss. Assuming only two tenants are no longer paying rents, cash flows should be enough to cover the loan interest increase.
According to a Realty Income Moody evaluation, loan-to-value (LTV), net debt to EBITDA and fixed charge coverage are the metrics under analysis. One criteria also used in covenants is the Interest Coverage Ratio.
The Covid crisis shows that the leading indicator to follow is the rent collection.
The following data from Spirit Realty shows the rent collection discrepancy between industries. There is a huge discrepancy between movie theaters that are closed and grocery stores. One should note that the economic downturn is only at the beginning.
Using a longer time horizon and the Realty Income portfolio, we can see that the occupancy stayed strong even during economic downturns (2001 and 2007-2009).
Usually, you need to find another tenant. The issue is that if one tenant didn’t succeed at the current rent, it’s likely that the rent is too high and will be reduced by market forces. The construction also limits the usage: an auto repair shop can’t be used by a 7-Eleven. At worst, the whole construction needs to be rebuilt.
It is in the interest of all parties to find an arrangement if possible by diminishing the rent.
We didn’t find statistics on the default of Single Tenant Leases. As they are linked to the credit score of the tenant, we can use the realized default rate from credit ranking as a proxy. The chart below illustrates the point for S&P credit scores. We can see that with investment grade tenants, the default rate is around 5% after 20 years for a BBB score (corresponding to Baa in Moody’s notation). This is what can be expected at worst for investment grade tenants.
If we go lower in the credit score, things quickly deteriorate up to a 50% probability of default for ratings in the Cxx range.
The market seems fairly liquid for finished constructions as there are 3000 properties on sale currently. Quite obviously, when times are hard, the market can freeze and there is a flight to quality. While it is very difficult to sell a movie theater currently, very high quality properties can be sold for a price never seen before.
For unfinished constructions, there is no evidence that such a market exists at all.
The asset originator and manager of the SPV is 6S Capital LLC. We expect that most deals (if not all) will be sourced from its sister company 6S Development LLC. This risk is somewhat mitigated at the Trust level (see the Implementation details section).
Jordan Amyx - LinkedIn
Matthew V Rabinowitz - LinkedIn
“6s Development has completed 11 of these projects. ~$35MM deployed and exited. “
“Zero defaults. All tenants paying their rent and all projects divested on schedule”
The due diligence from LendCo to issue a loan is quite extensive. It contains an analysis of budgets, usage of by an external appraiser and all the legal documents one can ask for.
Each operation should be accepted by the “Bank” which in our case is the Trust. Therefore it is the Trustees that check if the loan is in accordance with the Revolving Credit Agreement.
The valuation of a property or a construction project is only done at the closing of the operation and never reassessed after that. It is done by a licensed appraiser selected by LendCo.
For construction projects, developer fees are included in the project valuation.
In this specific case, there can also be a default of 6S Development which obviously never happened during the lifetime of 6S Development but can happen in the future. In such a case, the Trust will have to deal directly with the projects and properties.
Defaults are rare in this industry because they are not randomly distributed. They occur when a tenant defaults, which is more likely to happen in economic downturn.
In some cases, an external platform may be used to facilitate tokenization of assets and management of asset pools outside of the Maker vault.
No external platform is used for tokenization.
Provide the mechanics of the vault management. This can follow the Centrifuge Model, the Trust Model or something specific. Please detail any deviation from the model if applicable.
The process is outlined in MIP13c3-SP4. Legal risks inherent to this approach are outside of this risk evaluation.
The MIP delegates most of the work (and power) to a Trust managed by a third party Trustee. The Trust manages its relationship with the SPV (LendCo) using the Revolving Credit Facility Agreement defined in the MIP.
Wilmington Trust (as this stage, the expected Trustee) is one of the top 10 largest American institutions by fiduciary assets. They will be in charge of managing the Trust.
Wilmington Trust made some bad loan investment to small real estate developers before the subprime crisis. To cover for their mistakes, the President and the CFO dissimulated hundreds of millions of dollars in matured, past due loans. They were sentenced 6 years of prison term. While obviously unlikely to repeat, it shows that trust shouldn’t be given too easily even to a reputable 100 year hold Trust management business.
In the process outlined by MIP13c3-SP4, Maker Representatives should be in place to avoid such issues.
The MIP defines 5 levers that are under the responsibility of the Maker Governance.
- Aggregate Debt Ceiling
- Risk Premium - Interest Rate
- Scope (may be modified by MKR governance ratification of a LendCo request)
- Equity Requirement per LendCo transaction (may be modified by MKR governance ratification of a LendCo request)
For the debt ceiling, the minimum is set at 15M DAI with a forward guidance to 100M DAI. The amount needed is for two reasons. First, due to the trust structure which is costly, it doesn’t make sense to have a low debt ceiling for the borrower. Second, part of the risk reduction is due to the diversification of the projects and the tenants. Considering an average of $2-5M per project, a $20-50M debt ceiling seems a minimum for risk diversification.
For this kind of collateral you can’t start with a low debt ceiling, see if things are working, then increase it after a few months. It is unlikely that any issue arises in the first year at least as defined by the Revolving Credit Facility Agreement.
For the interest rate, the term sheet cap is at Wall Street Prime + 100 bps which is 4.25% at the time of writing.
The scope can be modified by Maker Governance only by a request from LendCo which defeats the point from a risk perspective.
The equity requirement by investment is capped at 30% which is already the value for a new construction project.
The liquidation is the main action Maker Governance can take. There is a 12-month notice before the actual liquidation starts. One should be careful in the definitive wording (the final contract is not written yet). There are a lot of occurrences in the term sheet where a liquidation can only be triggered by a covenant breach on top of a Maker Governance decision. Covenants are quite light so this can remove the ability of Maker Governance to get back its loan.
Nevertheless, Maker Representatives have all the due diligence information on every investment project a week before the credit line is drawn by LendCo. That will leave enough time to reduce the debt ceiling and avoid the transaction by letting a risk domain facilitator issue an executive vote. In this sense, there is a control of all investment.
Covenants are already detailed in the Term Sheet in MIP13c3-SP4.
There are two dimensions on the allowed investments. For the developper (who will own the equity of BorrowCo), there is no limit to who LendCo can choose. Due to the familiarity we can expect 6S Development will be quite frequently used, at least at the beginning.
For the tenants, there is a list that defines where most of the investments should be done. It is important to note that there is no limit in the credit quality of those tenants. As we have seen some tenants on the list are defined by Moody as highly speculative and are at the bottom of the group defined as “judged to be speculative of poor standing and are subject to very high credit risk” just a rank above the “likely in, or very near, default” group. Another tenant has unilaterally reduced his rent.
Asset / debt amount (with accrued interest)
The assets are defined being the construction cost. It is not expected to evaluate assets in a mark-to-market way after the BorrowCo loan is accepted.
The collateralization is used only at the beginning of a project (close of the transaction). From 15 to 30% of equity must be used per project. This equates to a collateral ratio between 118 and 143%.
There are no rules to avoid concentration risk. There is an indication of it in the “Other Lending Constraints” section but it is unclear at the time of writing who set those constraints (LendCo or Maker). As suggested by an expert we have consulted, we might want to limit exposure to up to a maximum of 10% of the assets for each tenant and 30% for a group of BorrowCo (BorrowCo’s from the same developer). Having a limit on non-investment grade tenants would also makes sense as a lot of risk is concentrated in those.
The stakeholders risks should at least be the financial stability of the asset originator. This part should be assessed even before the vault is opened.
The equity providers of the SPV/LendCo are external Accredited Investors. It will be needed to assess what rights equity holders have in the final version of the shareholder agreement of 6S Capital Partner LLC.
6S Developer LLC, 6S Capital LLC or the management are not expected to have “skin in the game” by being shareholders themselves. There is an informal rule that the Risk Team asks for asset originators to put money in the SPV. Nevertheless, they support all the legal costs of setting the infrastructure which is significant.
At this stage, no extensive due diligence was done on them and we can’t assess their financial stability.