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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CCIM.COM Rated companies with strong brand recognition and healthy balance sheets, such as national drug- stores and fast food outlets, often lease spaces with triple-net leases. When looking at net-leased single- tenant properties for nonrated tenants, analyzing creditworthiness is absolutely essential. Although freestanding buildings net leased to credit tenants are highly desirable, these lease agreements, which are drafted by or for the ten- ant, have multiple opportunities for the tenant to terminate the lease for reasons beyond the land- lord's control. For this reason, net leased single- tenant properties potentially can be too risky for landlords, especially when dealing with non- rated tenants. Mitigating Risks Since most triple-net leases are for single-tenant properties, the space is either 100 percent leased or 100 percent vacant — and the risks are much higher when dealing with nonrated tenants. For this reason, investors are advised to consider how the property could be repositioned and at what rental rates or cost to the landlord if the tenant cancels the lease for a reason beyond the land- lord's control. This is a critical part of the analysis because many deals today have triple-net lease ten- ants paying above-market rents. A few examples of single- tenant triple-net leases allowing the tenant to end the lease term if: 1 The tenant is unable to maintain a certain dollar volume in sales. 2 The property sits at an intersection with no median in the center of either road, and a median is added to either road with or without taking additional land covered by a lease. Some leases provide that the tenant can terminate the lease. If this happens and the debt is based on having the lease in place, the debt might well be called. 3 The property sits at the intersection of two major streets and one or both are widened, restricting access to the business during the lease term. 4 There may be a combination of some or all of these points. The landlord can include additional clauses in the lease that allow the tenant to terminate, which is often the case. If the lease is terminated, the landlord must con- sider the future use for the property. For example, can it be leased for the same rate the previous tenant paid? Or will the space need to be repurposed and leased to a new tenant at a much lower rate? Understanding the creditworthiness of prospec- tive tenants can help landlords make smart decisions about whether to lease single-tenant properties with triple-net leases to nonrated applicants. Remember, a lease is only as strong as the tenant that signs it. Staying Solvent Most landlords will not pass up a nonrated tenant for a space that is empty, especially if the space has been empty for a long time. For all practical purposes, leasing to a nonrated tenant who has a history of paying its rent on time and taking care of the property far exceeds covering carrying costs out-of-pocket. Follow the steps above to help out- line creditworthiness for nonrated tenants. A landlord who is a long-term holder of property and starts out with rated tenants will likely eventu- ally be left with empty space at the end of initial lease terms, leaving the landlord to deal with a sec- ond generation, nonrated tenant. For continued suc- cess, landlords must evaluate the creditworthiness of prospective tenants and write leases that establish options for maximum protection before allowing tenants to sign on the dotted line. No cookie-cutter formula exists for determin- ing the creditworthiness of nonrated tenants; each case requires an independent evaluation of the facts. Conducting a thorough credit analysis is a criti- cal part of being a successful developer or broker. Undercapitalized property owners generally cannot carry the debt when they have a tenant who does not pay its rent on time, and the loss of one tenant can be devastating to a small landlord. Mohammed Idlibi, CCIM, is principal manager at True Summit Capital in Charlotte, N.C. Contact him at midlibi@truesummitcapital.com.

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