6 Credit Enhancements

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Merry Christmas and Happy Holidays to you and yours, dear readers! With 2020 rounding third and heading for home - left in my stocking were some transactions that require a nudge in security. We generally see such enhancement requests in lease transactions although one of our lumps of coal is a sale. A review of our solutions is the subject of today’s missive - so buckle up.

As previously discussed, a lease deal is an extension of credit from the owner of the real estate to the occupant. Simply, a landlord will 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 - promised is approximately $2,000,000. Don’t forget to layer in the cost of rent concessions, tenant improvements, brokerage fees, and the like. For our example, we’ll assume these add-ons escalate our amount by 10% - another $200,000. So, our title holder wants to be assured the new tenant can fulfill a $2,200,000 obligation. If after reviewing the financial information provided, a doubt exists - expect the lessor to push for an enhancement. The form and format can morph. Below are some ideas. 

Personal guarantee. Frequently the tenant is a corporation. The C or S version has is a legal unit with underlying owners. Depending upon the complexity of the corporation, the ownership may be an individual or a number of shareholders. In the case of the former, a simple understanding the individuals are responsible if the corporation defaults can shore up performance. Sans a tangible individual - like in the case of a publicly traded group - personal guarantees aren’t feasible. 

Additional security deposits. Quite easily. Typical upon lease execution - rent for the first month and a sum equal to the last is deposited with the owner of the building. Sure. Some lease language allows the security deposit to cover abnormal premise wear and tear - but the primary purpose is to insure timely rent payments. Increasing this amount two or three fold can give some parcel owners a reason to say yes. 

Letters of credit. Good in theory - tough in practice. In essence, requested is an amount of future borrowing sufficient to stem the bleeding. But, if the tenant is sketchy - encumbering their ability to seek financing is difficult. I’ve seen this requirement spook occupants. 

Entity guarantee. Multi-layered corporations create operating companies akin to the layers of an orange. Once you peel back the skin - where’s the fruit. Sought by a holder of commercial real estate? The company signing the lease needs to own the assets - cash - capable of paying the rent. If not, a hollow barrel exists. Try drinking from said barrel. Yep. Nothing there. We’ve solved this in the past by requiring a parent corporation to sign. Just make sure the parent has chops. If not you’ll have an empty guaranteeing an empty. 
 
Reduction in concessions. Generally, we see two types of tenant requests. One of those is free or abated rent and the other is above standard office improvements. In the first case, lessening the amount of free rent requested can solve the problem. Maybe - vs a free month - two half months can be substituted. Or, placing the abatement in the later years. With tenant improvements -  two issues exist. There is a cost associated with producing the over standard build out. Plus, if the tenant doesn’t live out the lease term, the owner is faced with above standard goodies which may not have appeal.
 
Other solutions. Maybe pre-pay some months of rent. A well funded startup with adequate capital reserves but a short time in business will find this palatable. Consider a 
shorter term. In our illustration above - going from five years to a three year term and a two year option to extend may be all you need to do. 
 
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.