5 Strategies for CRE Pros to Use in Tenant Credit Assessment
Determining whether to enter into a commercial lease with a prospective tenant involves more than a simple credit check. Commercial spaces and tenant uses have evolved into a complex matchmaking process that depends as much on the lease particulars as it does on the tenant’s ability to fulfill the lease obligations. Therefore, property owners are wise to be particularly diligent in assessing commercial tenants’ credit in relation to potential lease terms. Here are some actionable strategies to do it right.
Many property owners most intuitively recognize this step as a tenant credit check. However, experienced companies like (RE)meter understand the scope of this process to exceed a basic credit score and review of financials. In the underwriting process, property owners should also check the tenant’s industry of business for stability and future outlook, the guarantor’s credit including financial records, cash on hand, and business plan. It is also a good idea to get a personal guaranty and signature of spouse to help backstop the lease. The more signatures on a lease (that add value to the tenancy, that is), the better.
- Credit Enhancement
In assessing a commercial tenant’s credit, enhancements to the application can be considered as well. One of the most common credit enhancements includes a security deposit. While legal provision is made for this instrument in a residential lease, the commercial side of real estate is less defined for security deposit. Ideally, a tenant should provide cash as security, but in some instances, a letter or line of credit can be accepted as well, again depending on the credit of the tenant. For instance, if a tenant receives a TIL Score from (RE)meter of 411, than the risk of the tenant being higher would require a larger, cash security deposit to be held by the landlord for the duration of lease. This instrument can add padding to a lease in the event a tenant’s credit is less than stellar based on history or unestablished due to the startup nature of a business.
A common alternative or supplement to securing credit for commercial tenants is requiring a company or individual to be used as guarantor to a lease. The value of the guaranty is dependent on the credit status of the guarantor. Adding a guaranty to the lease will give property owners another avenue of pursuit in the event the lease terms are not met (e.g., early termination, unpaid amounts).
- Tenant Concessions
While this may sound like more of a value to tenants, tenant concessions can help assess a tenant’s credit by incorporating incentives and rewards for tenants in their fulfillment of lease terms. As David P. Resnick explains in “Strategies for Assessing Tenant Credit,” “Limitations like these [e.g., security deposits] can take a variety of forms, from a fixed term to a cap on the guarantor’s liability based upon a fixed dollar-figure or factor of rent payable under the lease, to an automatic reduction of either the security deposit or the cap on the guarantor’s liability over time.” The win-win with tenant concessions is they are earned over time with “good behavior,” and reward the timely payment of rent and responsible care of the leased premises.
- Lease provisions
Additional lease terms can be arranged in variation to the credit assessment of a commercial tenant. For example, scheduled escalations for rent, control of approval of transfer, retaining property operation approval rights, and specific-use provisions can strengthen the lease. The assessment of a commercial tenant’s credit can be used to determine to what extent and with what level of flexibility a property owner creates a lease. For example, controlling the approval of the transfer right can allow property owners to accept or reject the transfer of the business to another owner. Collier International explains, “It also ensures that any new tenant conforms to your specified-use provision, has sufficient financial circumstances to optimize their probability of success and meets all credit requirements.”
To see how these strategies converge into a comprehensive commercial tenant assessment, download (RE)meter’s free (RE)port. The TIL Score can be used to design a healthy lease for landlords to protect their capital and enhance their properties’ value.