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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CCIM.COM January | February 2018 35 In the millions of strip malls nationwide, owners might deal with one supermar- ket or big box store — a rated tenant — and dozens of smaller businesses that are nonrated tenants. Although nonrated tenants such as restaurants, nail salons, boutiques, and office tenants may be creditworthy, no existing methods consistently and accurately rate these tenants. As with banking, real estate leasing does not have foolproof strategies to make credit decisions. Despite the lack of a credible rating process to judge credit, landlords execute leases with nonrated tenants every day. In fact, these tenants make up the vast majority of commercial leasing tenants. Determining Creditworthiness A creditworthy tenant is one that will pay its rent on time and uphold all of its lease obligations throughout the lease term. Evaluating creditwor- thiness in advance will help protect the landlord from funding tenant improvement allowances only to see the tenant's business fail. With a nonrated tenant, the act of determining creditworthiness falls to the landlord and involves a thorough study of a prospective tenant's financial history, rental history, and an analysis of the current viability of its industry. Net worth also figures into consideration for determining creditworthiness. Many tenants with financial statements show a large net worth, but bankruptcy courts are filled with cases of tenants with large net worth who can- not pay their bills. For this reason, net worth is just one consideration in evaluating nonrated tenants. Net worth is better used as a consideration of the amount of credit that might be extended, not the prime determinant in the decision to lease space. As part of determining creditworthiness, a credit analysis is essential. This process is based on five factors. 1. A rev iew of f inancial records. Review tax returns, balance sheets, income statements, and any other financial records that will give land- lords insight into the financial strength of the prospective tenant. 2. Payment track record. Does the tenant pay its bills in full and on time? 3. Rental history. Did the tenant keep its previous leased space clean and neat? Was its last vacated property left in good condition? What is its rela- tionship like with neighboring tenants? Under- standing why a prospective tenant is leaving its current location also is essential. 4. Assessment of the industry. What is the current state of its industry? Tenants in industries that are thriving are more likely to be successful than those in industries that are struggling to retain a foothold in the local economy. 5. Tenant attitude. Ask a tenant about its rea- sons for choosing this property and location. The tenant's attitude could be a clue about its business acumen and determination to see the business succeed. Using these factors to assess a prospective ten- ant's creditworthiness provides the landlord with a level of comfort about whether the business will be successful, and whether the tenant will fulfill its obligations under the lease. Remember, this process always is evolving and should be revisited as new information and tools are available. Landlords need to periodically reevaluate the credit of their tenants. How to evaluate whether nonrated tenants are creditworthy. C R E D IT W O R T H I NE S S Jeffrey Hamilton