Tenant Creditworthiness…A Complicated Discussion

Commercial landlords and real estate brokers have been forever locked in a battle over the amount and timing of landlord paid compensation, especially when landlords are unsure of the quality and stability of particular tenants.  Landlords contend that because brokers bring tenants to landlords, that those brokers should be responsible for their tenants’ creditworthiness and should participate in the credit and other risks borne by landlords.

I’ve written a lot on this subject. Landlords are in the risk management business. Commercial real estate brokers are in the fee for service business, and are therefore not in the business of accepting the type or quantities of risks that landlords accept. Accordingly, this matter is more appropriately one to be had between landlord and tenant.

The reality is that commercial tenants are responsible for their own creditworthiness, good, bad, or otherwise.  And, while landlords are in the business of bearing acceptable levels of risk, neither landlords or brokers should bear unnecessary or unreasonable amounts of risk on a tenant’s behalf.

In assessing the financial wherewithal of commercial tenants, landlords will consider numerous factors, including a tenant’s:

·         Business history (number of years in business, stability, growth and contraction)

·         Industry stability (software, personnel, other)

·         Place of incorporation

·         Country of origin, treaties between that country and the United States, and the ease or challenge with which a landlord can expect to contend to collect amounts owed, before lease provisions, ensure tenant performance, and more

·         Financial statements and other information provided by tenant

·         Bank references

·         Rent payment history

·         Legal history

·         Creditworthiness

·         Credibility of the management team, investors, and others

·         Tenant’s willingness to proactively provide information and insight, and answer questions

·         Landlord’s ability to understand tenant’s business model and horizon

·         Tenant’s negotiating posture, responsiveness, and reasonableness

·         Tenant’s required business terms, cost of construction and other transaction components

·         Tenant’s desired length of lease term

·         And, more

A landlord’s perception of the riskiness of a particular tenant can affect almost every part of a transaction, including:

·         Annual rental rate

·         Rent increases (amount & frequency)

·         Free rent

·         Construction and other allowances

·         Rights and options to expand, contract, terminate, renew, purchase, other

·         Non-monetary business terms

·         Security deposits

·         And, more

Security deposit requirements can make or break a deal.  Tenants perceived to have superior credit and long-term stability can often expect to pay little or no security.  This can change depending on the particulars of any transaction, including the need for the tenant to secure large construction allowances, free rent, or other monetary concessions and incentives.

Some landlords prefer to receive cash security deposits, while others insist on letters of credit.  Other landlords insist that all cash investments required of them to complete a transaction, including those for construction, commissions, legal and administrative costs, free rent, and more, be secured.  When landlords perceive a tenant to be very risky, they may require that the tenant guarantee all rental payments in some manner.

It must be said that certain landlords, because of their own financial challenges, may inaccurately view certain tenants as more risky than they really are.  The issue of landlord risk is one on which tenants should directly focus before entering into any real estate transaction.

When it comes to securing a real estate transaction, effective communication between landlord and tenant, whether directly or properly coordinated through tenant or landlord brokers, is essential to understanding risk and distributing that risk in a balanced manner in any transaction.

As for brokers acting as guarantor of the tenant’s creditworthiness and performance of lease obligations, that’s about as absurd as brokers guaranteeing landlord credit and performance.  Brokers are fee-for-service professionals, not credit analysts, nor guarantors.  Frankly, if a tenant is viewed by a landlord to be risky, that landlord has many alternatives available to it to mitigate that risk, including not entering into the transaction.  Commercial landlords and tenants each come with their own risk, as do brokers.  Accordingly, each party should be responsible for those risks for which they have traditionally been responsible, and should not seek to unfairly off-load those risks onto others involved in their transactions.

 

About Real Estate Strategies Corporation

Real Estate Strategies Corporation is a respected corporate advisory and transaction services firm that provides thought-leadership, decision-making, planning, project management, and transaction execution services to financial and senior executives at management team-led public, private, and portfolio companies, and not-for-profit organizations.   Under the leadership of its award-winning CEO, Andrew B. Zezas, RealStrat’s clients engage the firm when acquiring, disposing, renegotiating, or enhancing occupied leased or owned real estate in New Jersey, Pennsylvania, New York, Connecticut, and throughout North America.  By creating and executing Business DRIVEN Real Estate Solutions and identifying hidden Opportunities, RealStrat drives greater operational and financial performance in support of its clients’ stakeholder objectives, M&A requirements, and exit strategies.

In the current economic environment, RealStrat’s efforts are focused on uncovering, capturing, and re-purposing hidden liquidity and minimizing risk in its clients’ leased and owned real estate.  The firm provides counsel as to competitive advantage strategies in preparation for the eventual economic recovery.  Visit www.RealStrat.com.

Acquire new ideas about commercial real estate at RealStrat’s blog at http://www.CorporateAdvisor.wordpress.com.   Follow RealStrat and Andrew Zezas at http://www.Twitter.com/RealStrat.

Check out The Executive’s Guide to Understanding Corporate Real Estate Transactions.

Where is Andrew Zezas?

 

 

Copyright Real Estate Strategies Corporation 2010.  All Rights Reserved.

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2 Responses to “Tenant Creditworthiness…A Complicated Discussion”


  1. 1 Christian Molloseau January 2, 2011 at 9:48 pm

    I would disagree if this article was about residential guarantees (limited), but I cannot speak on commercial topics as I am not an authority. Nevertheless, I thought it was a well written blog!


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