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Strategies for Assessing Tenant Credit

By David P. Resnick
December 31, 2014

When considering a lease, tenants are usually focused on the location, size and quality of the leased space, and perform some minimal diligence on the landlord and property manager to ensure fair treatment over the course of the term. Landlords have a more difficult task, however. A prospective tenant, and most importantly, that tenant's ability to pay rent, is often unknown to the landlord. In recent years, real estate professionals have witnessed expansion in the array of users of commercial space and at the same time, property owners have been compelled to seek out new types of tenants. Increasing numbers of startups and new ventures, many of which are backed by various types of equity financing, are seeking to lease space. As a result of these changes, landlords should be particularly vigilant in understanding how their tenants make money, as well as the financial identities of the parties backstopping the obligations of those tenants.

Landlords should always analyze tenant credit in the context of the lease. After all, the success of leased real estate, as well as the property owner's ability to borrow against that asset, is dependent upon the stability of its tenants. While rent is the primary economic factor in any lease transaction, other factors such as term (including rights of extension), area of the premises (including rights of expansion and rights of first refusal on additional space) and the scope of tenant improvements create the platform upon which a tenant's credit can be evaluated. For example, substantial build-out (regardless of who pays for it) may inhibit re-letting the space following a default. Therefore, landlords should be mindful of the tenant's capacity to pay its construction obligations, which capacity is usually encapsulated in the tenant's credit and litigation history.

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