Proceed with Caution When Chasing Non-Credit Tenants
Economic and political headlines in recent weeks nourish the anxiety in many commercial real estate portfolio and asset management professionals. Amidst all this noise, it is easy to miss some of the potentially troubling signs in the U.S. and global economies. We tend to focus on the positives, like U.S. nonfarm unemployment of 3.8% and 2.2% GDP growth in the first quarter of 2018. Amid these bits of good news, we are confronted with challenges related to wage growth, climbing inflation rates, and the escalating conflicts with our trading partners (no source needed as this appears to change every day). Next week may also bring us our first yield curve inversion since the financial crisis (Read more about it in our April 11 post), which could be the siren song of a pending recession.
Timing economic and business cycles is challenging, but planning for them does not have to be. Recently, in the course of our regular tenant credit reviews, we have looked at an increasing number of non-credit tenants. These tenants, like all tenants, will face new operational and financial stresses if the economy weakens, especially those either burdened by high debt or those that have yet to turn a profit. Our advice in these seemingly transitional times is to proceed with caution when confronted with tenants that have questionable credit or expose ownership to outsize cash flow risk. We suggest a two pronged approach: 1) structure lease terms that are more closely aligned with the credit risk of the tenant, 2) include credit enhancement provisions that burn down only if the tenant adheres to certain financial covenants. Check out our April 5, 2018 post on getting the right burndown metrics for ideas, and reach out to us to learn how we can support your leasing and acquisition activities.