Commercial tenant screening?

Question

How would I go about screening prospective commercial tenants?  I tried searching this topic on BP but so far, haven't found a discussion.  So does it not exist or is it no different than residential tenant screening, where I screen the owner of the business personally?

Today, I spoke to a lady on the phone and she indicated that she wanted to rent the space I have available as a church.  If this is a "start-up" than how do I screen?  Would I screen them as a person as if she is applying for an apartment since this is a brand new entity?

What if her church is a existing entity? Is there a way to screen business entities to check for evictions or court cases?

Thank you in advance any help.

Joel Owens · Answer

Some commercial lenders I have seen will not fund on properties with churches on them. The churches stop paying and it can be a stigma for the lender and bad press they do not want having to foreclose on the church.

Depending on the churches day and night service schedule they can also be a parking lot hog which affects your other tenants and spaces for their customers.

Churches are usually better better not as a inline space or anchor but with land and space of their own.

Joel Owens · Answer

Diem a lot depends on the selling price of this property and the "under writeable cash flow".

The lender regardless of your numbers for lending purposes will take ( market vacancy average, tenant improvements, and estimated leasing commission ) and get to a UCF though an appraisal. That will determine the LTV the lender will lend at for the buyer which affects the buyers cash on cash returns.

Definitely do not want two church's there. That would take up a lot of spaces for other tenants.

I would have to get information on your property to give an opinion of what it would sell for. You want to know the issues of the property before trying to sell it so it is in the best light possible and an easy as possible transaction happens.

I would not burden your buyer with crappy tenants to fill It up. Many buyers actually look for 82 to 85% occupancy levels because this was if the lender underwrites for 7% vacancy for market at 93% occupancy there is still meat on the bone for the buyer to increase cash flow through additional lease up.

Joel Owens · Answer

You would want a personal guarantee. You would need to see the personal financial statement of the guarantor for the lease for liquidity and net worth.

If they have a newly formed LLC the LLC doesn't have a history.

In retail many landlords do not like renting to church's. Lenders do not like making loans on them either for a strip center. The reason is some times church's abuse their power and do not pay the rent and then try to create a public backlash when you need to deal with them.

The success of the church is often tied to donations and offerings.

Church's also take up lot of parking on the weekends and sometimes during the week depending on how many services they have.

If you have a multi-tenant property this could heavily affect the other tenants.

Daniel Chang · Answer

@Diem Tran

Good question.  You can find thousands of posts on BP on how to screen residential, but very little on commercial.  I had to come up with something myself and this is what I came up with:

- D&B is only worthwhile if you are doing a large lease with a relatively large company.  Most of you small businesses like tax centers or churches will not have a D&B history

- For startups (<2 year operating history), regardless of whether it's a sole proprietor, LLC, or corp, I essentially screen the same way as residential.  Meaning, credit checks, background checks.  Most of these are owned by a single individual or a small group of individual.  So I get personal guarantees.

- For medium sized companies (usually incorporated) that has been in operations for awhile, I ask for last 2 years tax returns.  The tax returns tell you a lot.  It gives you the profitability obviously.  But it also verifies the EIN, the corporation name so that you can verify them against state records.

I don't really deal with very large companies or publicly traded.  I'd imagine I would get an experienced broker if I did.

Joel Owens · Answer

If the property is 100% occupied but market vacancy is 7% then lender will take off the 7% with the appraisal.

Seller will argue property is 100% but every property even with national tenants turns a space at some point in the center. When that happens you will need reserves for TI's and leasing commissions to fill the space again.

If a property is at 80 to 85% occupancy and the market vacancy is 7% then vacancy is already accounted for.

That is why I like 85 to 90% occupancy versus 100% as it is already underwritten with vacancy and some upside. If 100% I have to make sure in OM they are accounting for PM fee even if self managing and also vacancy. If not it will severely impact the amount of buyers down payment and reserves and not meet the buyers cash on cash expectations.

As to why a seller would leave meat on the bone for the buyer it varies. Some national companies that own centers buy them as value add and then lease up to 90% and sell and move on to the next one. They make money on velocity. If this was a one owner property where they just owned that one retail center and most of their equity is tied to it then I have found they typically want to extract every cent they can out of it before selling.

Every deal is situational. There will be commonalities deal to deal but variables each time to work through and close the sale. I learn something on every single transaction.

Brian T. Grooms · Answer

@Joel Owens Are you that saying many buyers actually like 82 to 85% occupancy because of the room for value add by increasing the occupancy? You mean that with 82 to 85 % occupancy the NOIs (actuals) are keeping the valuation lower for the buyer? This would make sense to me, but seems like it would not be benefiting the owner (I also realize poor quality tenants at higher occupancy is definitely not good for the owner either though).

Also, why would the lender underwrite for 7% vacancy with actuals at 82 to 85%. Do many lenders you work with underwrite based on the market as a whole rather than actuals for a specific property?

I am a new commercial realtor, I come across your posts often, thanks for sharing your knowledge and experience with the BP community!

Alan Mackenthun · Answer

Good question.  My wife and I have done a fair amount of single family investment and are determined to get into larger scale retail or multi-family investments.  We've learned the value of tenant screening, but screening commercial tenants is a whole other deal.  I expect to put professional management in place at least initially and learn from them.  It would be nice if there were more commercial resources available here on BP.

Diem Tran · Answer

@Joel Owens @Marc M. And btw , this space that we're talking about is on the second floor. It's been vacant for about 2 months.

Diem Tran · Answer

@Pavel Sakurets thank you!

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