The biggest bane to Los Angeles and greater Southern California retail shopping center landlords?
Each day a unit in your center sits empty is money lost.
And sadly, that’s money you’ll NEVER recover.
While there are several critical steps you can take to minimize your property’s vacancy rate, one measure in particular stands out.
Carefully vetting prospective tenants.
There are a number of factors that strongly indicate a tenant’s potential for success. These indicators include a prospective tenant’s:
- Credit history
- Financial position
- Past operator track record
- Ability to secure a lease guarantor
It goes without saying landlords should closely examine and carefully evaluate these factors when considering a prospective tenant.
Of course, there are no “guarantees.” Unfortunately, no landlord or real estate professional has a “crystal ball.” Thus, it’s impossible to say with absolute certainty whether a particular tenant will succeed.
There are a number of possible mitigating circumstances…
- A personal, professional, or financial setback
- A sudden or unexpected turn in the economy
- An unforeseen shift in a particular market
These, along with a host of other eventualities, may come to bear on a tenant. Circumstances that can send their operation into disarray, and ultimately forcing them out of business.
But all of this said, analyzing credit, finances, and business track record provides a strong impression of a prospective tenant’s potential performance.
And toward that end, here are the key elements to consider when evaluating a prospective tenant:
Running a credit check is your FIRST line of defense.
A credit report that returns a bankruptcy, foreclosure(s), eviction(s), outstanding collections, or late notices should give you pause. These are all SERIOUS red flags.
In some cases, there may be mitigating circumstances. And if the prospective tenant appears desirable and otherwise financially healthy, it may be worth further investigation.
You could offer them the opportunity to…
- Explain their checkered credit history
- Provide additional documentation disputing their credit report
- Provide a guarantor on their lease who will take financially responsible should they default on the agreement
But generally speaking, a tenant with these sort of dings on their credit record is far more likely to be problematic. And as such, they’re probably not the type of tenant you want to invite into your shopping center.
With a clean credit report in hand, your next request is financial documentation.
This includes tax returns, bank balances, other financial asset statements, P+L statements for other current or prior businesses, and the like.
What is the tenant’s annual income, according to their tax returns?
If the business they plan to locate in your property is their sole source of financial support, and they show little or no annual income on their returns, that could be a red flag. Are they’re failing to turn a profit? Or barely earning enough to the cover operational expenses? If so, it could be that their business is not sustainable in the long term.
If the tenant appears otherwise desirable, it may be worth further exploration. In some cases, a tenant’s tax return shows they “make no money” to minimize their income tax liability. It’s not uncommon for business owners to “get creative” with their expenses to show a loss and avoid paying income tax.
If you’re interested in pursuing a tenant with this sort of financial track record, request an explanation. The tenant may be able to produce records that demonstrate their gross profits. And they may have additional documentation that illustrates their “true” net income.
Bank Balance + Other Cash
Every business is susceptible to unexpected financial hardship. It could be due to a lull in business. It could be a health or family issue that’s distracting focus from their business. It could be the result of an overall economic downturn.
Whatever the scenario, it’s important that the business owner has cash on hand to sustain their business in challenging times.
It’s tough to say how much is “enough.” But depending on the type of business the tenant’s operating, along with their monthly rent + CAM obligations, you can usually make a reasonable guestimate.
The point being, executing a lease with a tenant that only has few grand in the bank is quite risky. If they hit a “rough patch” (for whatever reason) their likelihood of default is well above average.
Cash isn’t always a tenant’s only asset. Again, for tax purposes, in addition to serving other financial logistics, a business owner may not show significant cash assets.
But in lieu of cash, what other assets do they hold? Stocks, bonds, and other financial instruments worth respectable sums? A home or other real property? Another productive business or businesses?
These are credible assets worth considering as acceptable financial collateral.
There is, however, a catch when qualifying non-cash assets. Ultimately, you need to evaluate how liquid the prospective tenant’s assets really are. Can they readily convert assets into cash if needed to fund their business?
Securities can be sold, but when converted under duress, they tend to capture below market value returns. In some cases, well below market value. Will the proceeds be enough to sustain an ailing business?
Homes can be mortgaged or sold, but both scenarios take time. And it’s fair to wonder if the resulting funds will arrive quickly enough to support the business in a time of dire financial need.
Assets are certainly reasonable indicators of a prospective tenant’s financial health. But asset liquidity is also an important consideration.
Business Track Record
With a clean credit record and a solid financial base established, the next issue is the tenant’s business track record.
Some key questions to consider in analyzing a tenant’s business track record…
Is the tenant the expanding or relocating an existing business? Do they currently operate a wholly separate business and are they planning to launch a completely new venture?
With a clear image of their circumstances in mind, what’s the past performance of their business (or businesses)?
A tenant that’s helmed a thriving business for five or more years is generally a solid bet.
Of course, if their business is turning a profit, but they have little to no assets, expansion is bound to be a dicey enterprise. Opening a “new location” of an existing business isn’t quite “starting at square one.” But the expenses involved are considerable.
Plus, you need to factor in carrying costs at their existing location(s) should those operation(s) “hit a rough patch.”
Even a relocation can be costly. And if a build-out and permits are necessary, not to mention that host of other potential add-ons that might come into play, the costs can be significant.
In short, without assets to support the expansion and maintain the tenant’s current business, there’s likely to be trouble on the horizon.
And What About Businesses With a Less Than Stellar Track Record?
A prospective tenant teetering on the brink of collapse, regardless of whether they’re looking to expand or relocate, is obviously a bad bet.
But what about a business that’s underperforming or shows inconsistent or production? If their credit is clean, they have sufficient assets, and you feel their business would synergize well with your existing tenants, it may be worth the risk.
Finally, What About a BRAND-NEW Business Launched By Inexperienced Operators?
A fair number of would-be tenants are looking to launch a new business. And many of these prospects have no prior experience running a business.
They may have worked in the same industry or a related industry. But they’ve never actually operated a business of any kind.
In effect, they have ZERO track record.
If they have a legitimate business plan and they’re well-capitalized, that mitigates some of your risk.
But with no prior experience and little in the way of assets, there’s a strong probability the tenant’s business will fail.
A possible solution to overcome these issues? A well-capitalized guarantor willing to guarantee the lease.
Let’s say the tenant is able to produce a guarantor – A third party with a clean financial bill of health and adequate liquid assets who is willing to sign a “guarantee of lease.” If the tenant’s business fails or they otherwise default on the lease, the guarantor steps in.
This third party then assumes the lease + CAM payments and takes on all of the original tenant’s financial responsibilities associated with the property. In most cases, it’s assumed the guarantor will operate the business themselves, or seek an outside buyer.
Executing a lease agreement with an inexperienced, unproven, or undercapitalized tenant unable to provide a guarantor is an extremely risky proposition. But depending on your circumstances, you may still be willing to accept that risk.
Need Assistance Vetting Prospective Tenants for Your Retail Shopping Center?
Are you a Los Angeles or Orange County area retail landlord or shopping center owner?
CBM can help! Vetting prospective tenants is a HUGE part of our leasing services. Our leasing agents gather credit reports, financial documentation, and business histories. And based on this information, our agents can make recommendations on selecting financially sound tenants with solid operator track-records.
For additional information, visit our Leasing Services page.