X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
Everyday, well-run companies strive to improve their credit ratings.  Banks search for companies to whom they wish to lend, based on their credit and many other factors.  Investors, landlords, business partners, companies selling products or services, rating agencies, and information consolidators, all spend countless hours analyzing the creditworthiness of companies, searching for the best and often deciding not to conduct business with those companies with poor credit.   So, great credit will put your company in a position of strength, right?  Well?  Great credit and a solid financial footing will certainly open doors that may otherwise be locked.  When acquiring real estate through lease transactions, great credit is what attracts landlords to certain tenants and affords those tenants better terms than their less creditworthy corporate brethren.  If your company has great credit, banks, investors, and others will race to do business with you at lower rates and on better terms than for other companies…right?  Interestingly, the answer is: “Not always!”   When could great credit get in your way?  That same great credit can become a 100 foot high obstacle when companies seek to sublease surplus real estate or assign leases that they no longer require.  With the growing amount of space offered for sublease or assignment, creditworthiness becomes a major issue.   A large focus of landlords is credit risk.  Since fewer and fewer companies actually have great credit these days, when a creditworthy tenant seeks to get out from under a lease by assigning it to another company, landlords will weigh the original tenant’s creditworthiness against that of the potential assignee.  Unless the incoming assignee’s credit matches or exceeds that of the original tenant, the landlord will likely do everything in its power to retain the original tenant in the liability chain and will not readily permit the original tenant to absolve itself of its obligation.  In fact, the landlord may not approve of the incoming tenant or the transaction at all.   From a risk management perspective, the landlord’s actions in this kind of situation are perfectly understandable.  Why would anyone swap bad credit for good credit, especially in the current economic environment where many seemingly good companies are now perceived as risky?   After reading the above, most financial executives considering acquiring real estate through a sublease or assignment transaction would likely start thinking about credit enhancement and additional security deposits.  At a time when sustainable and predictable cash flow is king and the risk of loss is high, additional security deposits won’t mean a thing to most landlords.    Think about it like this:  If a good credit tenant is permitted to be absolved of its obligations in exchange for a riskier tenant, and given that security deposits in commercial real estate transactions typically cover a small portion of lease obligations, what benefit would a landlord derive from any credit enhancement or additional security deposits?  Few, if any, commercial mortgage lenders would even consider authorizing a landlord to whom they lend to agree to replace the good credit of an existing tenant with the questionable or unproven credit associated with an incoming tenant.    How about credit enhancement?  The only way that credit enhancement would alleviate landlord and lender fears of increased risk and possible cash flow loss would be if either the outgoing original tenant or the incoming tenant guaranteed a very significant portion of a lease’s value, if not, the entire lease obligation, and could demonstrate the financial wherewithal to do so.  That’s exactly what most landlords would seek in this instance.  Unfortunately, guaranteeing an entire lease obligation would place the outgoing tenant right back at the starting gate of not being able to absolve itself of its financial obligations.  And, most incoming tenants are unwilling to make such a commitment. Afterall, landlords are as much in the business of managing risk as they are in owning buildings, generating cash flow, deploying leverage, and building equity appreciation.  And, that’s precisely what landlords must do in the current economic environment to sustain themselves…manage risk very well.  This is a time, when companies are seeking to relieve themselves of surplus lease obligations, that a tenant’s strong creditworthiness will actually work against it.   In this environment, there are times When Great Credit Can Be Bad.  Alternative approaches to disposing of surplus real estate, including the use of lease renegotiations and other non-traditional approaches, may be a strong tenant’s best bet.  

       

Want to continue reading?
Become a Free ALM Digital Reader.

Once you are an ALM digital member, you’ll receive:

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications

*May exclude premium content
Already have an account?

Dig Deeper

GlobeSt

Join GlobeSt

Don't miss crucial news and insights you need to make informed commercial real estate decisions. Join GlobeSt.com now!

  • Free unlimited access to GlobeSt.com's trusted and independent team of experts who provide commercial real estate owners, investors, developers, brokers and finance professionals with comprehensive coverage, analysis and best practices necessary to innovate and build business.
  • Exclusive discounts on ALM and GlobeSt events.
  • Access to other award-winning ALM websites including ThinkAdvisor.com and Law.com.

Already have an account? Sign In Now
Join GlobeSt

Copyright © 2021 ALM Media Properties, LLC. All Rights Reserved.