5 Signs a CRE Tenant Might Not be the Right Fit for Your Development
Many landlords and owners know painfully well how quickly a commercial tenancy gone south can disrupt an office complex or negatively impact a mixed commercial development. Anticipating how a tenancy will affect other tenants is important to consider in the early stages of the tenant screening process. Sure, there are exceptions to every rule, but in the business world, the risks of taking on a high-risk tenant are not worth the potential damage to commercial portfolios. Here are a few telltale signs that a commercial tenant prospect might not be right for you.
- Poor or insufficient credit history
When a commercial tenant has poor credit or insufficient credit history, the resulting low credit score usually indicates a stopping point for further lease negotiations. In the case of a start-up business where history may not be available for more than a couple years, it is more imperative that the credit history shows prompt payment of bills, a responsible debt-to-income ratio, and room for growth. (RE)meter’s TIL Report is the most comprehensive, reliable analysis of credit scores specifically designed for commercial tenants.
- Unwilling to sign lease beyond 1 or 2 years
The last decade has introduced new models of strategic leasing. Nevertheless, one thing remains consistent: CRE professionals value the longer-term lease. Peter Conte, vice president of Transwestern-San Francisco, explains, “Landlords still prefer standardized five- to 10-year terms, largely due to the methodology of underwriting buildings from an acquisition and financing model, which typically puts tenants’ and landlords’ interests in opposition.”
A commercial tenant’s unwillingness to sign a lease beyond one or two years may communicate uncertainty of the tenant’s business, although admittedly other factors may be at play. More information can be gathered during lease underwriting that probes for reasons, like whether the tenant is expecting to need more space or is under a defined government contract.
- Lack of collateral, guarantor, financial backing from more than sole owner
Tenants who cannot offer any collateral or backing from other credible sources might not be the right fit for your portfolio. In many ways, this yellow flag is related to the tenant’s lack of credibility mentioned in our first yellow flag. The use of a guaranty or collateral may be the only means by which landlords can recoup losses in the event a business performs poorly and a lease is in default. Tenants without such options may be an indication that they are overstretched, have exhausted all other resources other than their own, and might not be able to withstand market interruptions.
- Inability to pay adequate security deposit
When a commercial tenant cannot pay a security deposit, chances are the tenant is lacking cash flow, which may indicate instability. Letters of credit are another option for cash security deposits, which could turn the situation around. Either way, tenants not able to offer a security deposit could point to problems with tenancy in the future.
- Too good to be true
Then it probably is! This old adage rings true today in commercial real estate. CRE professionals beware of the tenant offering more than the asking. While it sounds heavenly, this offering is more likely to be an effort to avoid the usual tenant screening process. A tenant looking to avoid well-planned commercial leasing best practices is not likely to be the ideal tenant.
Above all, commercial tenants must be willing and able to make the case for themselves that they would take care of the premises and meet all lease terms and conditions. In turn, commercial real estate professionals must take good care to find tenants that will fit well within commercial portfolios, always seeking the “win-win.”