Magazine article Journal of Property Management

Red Flags in Commercial Credit Checks

Magazine article Journal of Property Management

Red Flags in Commercial Credit Checks

Article excerpt

Assessing a potential tenant's creditworthiness is one of the most important tasks of the real estate manager--and one that is frequently overlooked. Faced with the urgency of getting a lease deal signed, it is often tempting to just take a prospect's creditworthiness for granted. However, this hasty action is too often one that is regretted before the ink on the lease is dry.

Initial Investigation

A initial credit investigation should include a full credit report, including three years of historical data, as well as credit references.

If the company is less than one year old, it is also wise to investigate former companies in which firm principals were involved. Reviewing a new company's business plan and investigating the overall strength of the industry in which the company works may be beneficial.

For smaller, privately held companies or for partnerships (such as attorneys or doctors), personal credit reports on all principals are also essential. Even if the credit report for the company is solid, problems with personal credit, such as late payments or personal bankruptcies, should send up red flags. In some cases, it may be prudent to request personal guarantees from the firm's principals. The poor personal credit of one individual may not break a deal, but being aware of past problems may help you recognize new problems earlier.

If the tenant is a subsidiary of a larger company, be sure to investigate the financial resources of the parent corporation as well. See what contribution this subsidiary makes to the corporate balance sheet--is it likely to be sold off or closed? If the tenant's credit is questionable, a corporate guarantee from the parent company--for all or part of the lease term--may be worth obtaining.

Ideally, both vendor and customer references should hold a positive view of the company. Care should also be taken to check credit sources other than those provided by the tenant. This can be difficult if a credit check is done in house.

Credit agencies generally secure information from a wide range of sources and then correlate that data to match an individual company. In this way, evidence of credit problems is more likely to come to light.

Some Warning Points

In reviewing the credit report, consider how a company pays its bills. Does it pay within 60 days, or do payments often stretch to 100 days or more? Also notice if formerly prompt payers are beginning to stretch payments out; this may be an indication of financial difficulties. If there is an indication of financial problems, consider asking for a letter of credit, corporate guarantee, or increased security deposit before agreeing to the deal. And again, do not stop at the two or three vendors provided by the tenant.

If sales have been flat or declining, assess whether or not the problem is one of geography, the tenant's industry, or the individual company. If the entire region is going through a recession, small sales declines should not be weighted too heavily. But if the company is losing market share in a boom, there may be financial trouble in the future. Again, credit agencies may be of benefit as they can compare your prospective tenant's performance to others in the same field.

The company's business plan, financial statements, tax returns, and sales reports for the last two or three years are also key indicators of a sound financial footing. …

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