Mitigating Risk: Understanding Tenant Screening of Commercial Prospects
Background checks for CRE tenants can give CRE professionals a good indication of whether or not to proceed with the leasing process. Along with peace of mind, thorough tenant screening works toward finding a higher quality tenant and minimizing the likelihood of a lease going south. For the commercial industry, tenant screening begins with some basic background checks, but it shouldn’t end there.
Commercial owners should implement a plan of action for tenant screening that seeks to prevent fraud, reduce income loss, and make investments more successful. To do this effectively, an essential piece of this process will include developing a basic understanding of the tenant’s business or industry. This tenant-screening step can often make the difference in deciding what is best for an owner’s assets. Commercial tenants are not just leasing space for themselves. Instead, they are leasing space for their business. This is why it is so important for CRE professionals to seek information about not only the tenant but also the tenant’s business.
To this end, some basic questions CRE professionals should ask prospective commercial tenants include the following:
- What is the legal business entity?
- Who are the business’ expected customers?
- How long has the business been established?
- Who are the business principles or stakeholders?
These questions can help establish a basic understanding of the tenant’s business. Of course, part of the screening process would include business and personal financial statements of business stakeholders, if possible.
However, to further mitigate risk, CRE professionals in their screening of potential commercial tenants should at least develop a working knowledge of the overall industry of the tenant’s business. To this end, questions to answer include:
- Who are the expected customers (target market) of the business?
- How is the industry faring as a whole?
- How is a tenant’s industry performing in the market?
- What is the market outlook for the industry?
- Based on a tenant’s financial statements and past performance, are they positioned to withstand a market bump or other expected trend?
While a track record of a particular tenant’s success can be established by financial statements, knowing how the market is faring is another piece of the puzzle. For example, a tech company around the turn of the century may have shown fantastic profitability in the late 90s. However, leasing to them when the tech bubble burst may not have been a wise decision.
Finally, for new start-ups or new business owners, CRE professionals should request a copy of a business plan that describes how well the tenants know their industry and shows a history of the business, the ownership and management and their resumes, target market, and their operating budget. For new businesses, in particular, without a track record of operating profit and loss, CRE professionals will need to be confident of where the rent will come from before signing a commercial lease.