Five ways tenants, owners can seek credit enhancements on a commercial lease

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A lease agreement is an extension of credit from the landlord to the occupant. The landlord will simply calculate the total consideration of the agreement by multiplying the monthly rent plus annual increases for the term of the lease. If our monthly rent is $30,000 with 3% yearly escalators over a five-year span, the overall rent is $2 million.

When you layer in the cost of rent concessions, tenant improvements, brokerage fees etc., the sum grows bigger. Like for this case, let’s assume these add-ons push our amount by 10% (that’s another $200,000). So, the landlord wants to be assured the new tenant can fulfill a $2.2 million obligation. Being honest, this is not some amount of money that you can just bring out from nowhere. So, as a landlord, you can be a bit skeptical about the tenant’s ability to pay the amount in full and in good time. How can owners and tenants seek credit enhancements in such a case?

  1. Personal guarantee.
    More often than not, the tenant is a corporation. Whether a C or S corporation, both are legal units with underlying owners. Depending on the structure of the corporation, the owner may be an individual or a number of shareholders. In a case where the owners are the shareholders, a simple understanding of the individuals is necessary should the corporation default. The tenant can give legal promise to repay to pay what is required of them. And if the corporation becomes unable to repay the debt, the individual who’s the owner of the corporation assumes personal responsibility for the balance.
  2. Through additional security deposits.
    Upon the execution of the lease agreement, the rent for the first month and a sum equal to the last is deposited with the landlord. However, some lease terms allow the additional security deposit to cover abnormal premise wear and tear, but the primary purpose is to insure timely rent payments. Escalating this amount two- or threefold can give some landlords a reason to say yes.
  3. Reduction in concessions.
    There are two common types of tenant requests for enhancements. One is the free or abated rent while the other one is above-standard office improvements. For the case of the free rent request, reducing the amount of free rent requested can be the solution to the problem. This can be done through substituting two half months to give one full free month, or by placing the abatement in later years. For the request of tenant improvement, there are two issues. One is the cost associated with producing the over-standard buildout, while the second one is the case where the tenant doesn’t finish the lease term, leaving the owner with above-standard improvements that may not be appealing to the next tenant.
  4. Offering a letter of credit.
    A letter of credit is a is a letter from a bank or a financial institution guaranteeing that the tenant’s payment to the owner will be received on time and for the correct amount. What if the buyer fails to make a payment as required? In that event, the bank will be required to cover the full or remaining amount of the agreement. Letters of credit are known to be good in theory but extremely tough in practice. However, an amount of future borrowing can be requested to insure any bleeding. However, if the tenant is sketchy, their ability to seek financing is difficult.
  5. Entity guarantee.
    Multi-layered corporations create operating companies similar to the layers of an orange where you find no fruit when you peel back the skin. For such corporations, you need to ascertain they own the assets or have finances capable of paying the rent when signing the lease. If not, they could be making an empty guarantee that could get end up coned.

Work cited.
https://www.ocregister.com/2020/12/27/6-ways-tenants-owners-can-seek-credit-enhancements-on-a-commercial-lease/.

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