Commercial Investment Real Estate

JAN-FEB 2018

Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.

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COMMERCIAL INVESTMENT REAL ESTATE 36 January | February 2018 Considering Different Tenants Some nonrated tenants have established businesses with outlets in other locations. This might seem like an advantage on the surface, but an established business might still be a bad credit risk. In evaluat- ing a nonrated tenant with an established business, landlords must still consider the ability of the ten- ant to make timely rental payments. In the case where negotiations with a well-known tenant are conducted under a new entity that is wholly owned by the tenant's parent company, the parent company will provide funding but is not liable for tenant lease obligations. In such cases, the landlord needs to make a credit decision. Landlords that elect to move forward in the leas- ing process must discuss the cost of tenant improve- ments and sources of funding to make changes. This evaluation should include information about where the tenant will acquire funds to pay rent, make pay- roll, and cover the costs of utilities and supplies for a sustainable business period. If funding is coming from the parent company, landlords must take into account how long the par- ent company will provide funding and at what point the parent company will disentangle itself from the deal if the new entity is not successful. Consid- eration also should be given to parent companies becoming guarantors to the landlord. When parent companies are involved, the landlord must perform due diligence on the parent companies as well, assessing what type of tenant the parent com- pany has been with other subsidiary companies. Has the parent company ever had a subsidiary seek protec- tion under the bankruptcy laws? This due diligence should include the names and addresses of up to five landlords for other locations operated by subsidiaries of the parent company. The landlord should ask these four questions. 1 Was the tenant a single-location entity? 2 Does the tenant pay on time for its obligations under the lease? 3 Does the tenant take care of the property in accordance with its obligations under the lease? 4 Did the parent company guarantee the lease obligations of the tenant? When dealing with nonrated tenants with estab- lished businesses, the landlord should visit a location to observe its operations and ask about the current state of the business. Nonrated startup tenants also can be risky. Without existing operations in other locations, landlords have to rely on two factors to make judgments about whether the prospective tenant represents a good credit risk: 1. Does the tenant have enough cash on hand, or a loan in place, to do the tenant improvements that are required? 2. Does the tenant have enough cash on hand to make its payroll, pay rent, pay utilities, purchase supplies, and meet other financial obligations for a period long enough for the business to be built to carry these costs? Performing Due Diligence Owners also must perform due diligence beyond evaluating the financial stability of a prospective tenant's financials, researching the industry, and understanding whether the business will generate excessive waste or emit foul odors, and if its visitors will be compatible with other tenants. It's worthwhile for landlords to visit other tenants in the same businesses to view operations and ask about the state of their businesses. Whether a nonrated tenant is an established busi- ness or a startup, landlords should consider requesting a guaranty agreement. As part of the agreement, the principals of the business may be required personally to guarantee the full and faithful performance of all lease terms and agreements. If the tenant defaults, it agrees to pay all sums due from the tenant under the lease in a timely manner. Note that in some states if the guarantor is an indi- vidual and married, the spouse must also sign the guaranty agreement. In businesses where the guaran- tor is a corporate entity, a resolution authorizing the signer to execute the guaranty agreement is highly recommended.

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