Tenants

In This Article

• When a Tenant Downsizes
  • Implications for the Landlord
• Two Essential Types of Tenants
  • Credit Tenants
  • Anchor Tenants
• Appreciating Concepts: Basics of Rating
• FAQs
  • About the Author

Are you a landlord or an investor looking for ways to reduce risk when renting out your properties? If so, one of the best strategies is tenant selection. Regardless of how attractive and competitively priced your rental offering might be, if it ends up in the wrong hands, you could end up dealing with risky situations that can cost you time and money. Unfortunately, many types of tenants can place landlords at risk. These range from problem renters who cause damage to their rentals or those who have difficulty paying rent on time. Here we explore which kinds of tenants should be avoided to mitigate the risks associated with investing in commercial rental properties.

When a Tenant Downsizes

When a tenant enters a space, a lease is signed. A lease is a contract between the tenant and the landlord specifying the details of the agreement. These details include the exact space the tenant will occupy, for how long, the rent amount, and the arrangement of expenses. As the expiration of the lease draws near, the two parties will discuss terms for renewal. At that time, any changes to the original agreement will be negotiated.

When business is good, a tenant will generally not change much of the original terms when business is good. When the profits are not covering the costs, the tenant will look to change the terms to enable him to pay the monthly rent. One of the most common methods is for a company to reduce the space it occupies or downsize. For example, a company may halve its rent expense by having two employees occupy one office instead of each employee having his own private office.

It is a relatively simple process as long as the downsizing happens during the lease renewal. It is a bit more complicated when a company needs to downsize during a lease contract. A company cannot just “walk away,” from a lease. Usually, the rent is guaranteed by the tenant for the entire period of the lease. Larger companies are guaranteed by their parent holding company, and smaller companies offer personal guarantees. What options remain for a company in this predicament?One way to downsize in the middle of a lease is to sublet or sublease all or some of their space. A company that closes its doors and subleases its entire space in the building is known as a dark tenant. Subletting isn’t always allowed by a landlord and is usually negotiated upfront when the lease is signed. The landlord often has restrictions regarding who can sublease the space, and usually maintains the prerogative to approve or reject a prospective tenant. Other aspects of a sublease are negotiated upfront, such as whether the original or master tenant will collect all the rent from the new tenant or split it with the landlord.

Implications for the Landlord

It goes without saying that a tenant who, due to a financial crisis, stops paying his rent and leaves in the middle of a lease negatively affects the landlord’s bottom line. In the case of a sublease, however, the landlord continues to receive the full monthly rent. The same is true when the vacating company, or its parent company, can still afford to pay its rent as per their guarantee, even after vacating. In these cases, one might suppose that the landlord does not suffer any loss from the tenant’s downsizing. Unfortunately, it is possible for one vacating tenant, while continuing to pay rent until the end of the lease, to cause the financial collapse of an entire property.

The importance of each tenant’s space is not merely in the rent it brings in. For example, in a shopping center, each tenant has its own customers that come to that particular area for that specific store (see anchor tenant). If a popular tenant goes dark, consumer traffic diminishes to that center, and all the other tenants in the center suffer. These tenants may then reconsider renewing their leases once they come due in favor of another, more attractive area. In this case, the failure of one important tenant causes an entire property to go sour by starting a “domino effect.”

This is why it is so important to look at the entire picture when considering an investment property is so important. It is important to know who the parent or master companies are to ensure the rent is guaranteed. And it is equally important to ascertain which companies are actually occupying the space to anticipate the level of consumer traffic.

Two Essential Types of Tenants

An investor, who wishes to avoid unnecessary risk to his investment, will make sure that two types of tenants occupy a large portion of the property.

Credit Tenants

A credit tenant is a tenant with a good credit rating by a reputable rating agency, such as Moody’s or Standard and Poor’s (see Appreciating Concepts). Company ratings are a measure of its ability and willingness to repay debt. A landlord can feel confident that a tenant with a good credit rating will not go bankrupt or stop paying his rent. Typically, a tenant with strong credit will have income from operations from other stores or solid financial backing. Even in the unlikely event that this particular store is forced to close, they will still have the ability to carry out their financial commitments and pay the rent for the remainder of the lease.

Anchor Tenants

An anchor tenant is the main tenant in a shopping center, which serves as a draw for consumer traffic, thus giving maximum exposure to the ancillary (non-anchor) tenants or the smaller satellite stores. In a large center, there may be more than one anchor tenant. Since an anchor tenant is so desirable for landlords, they are given better rental terms. (See Appreciating Concepts.)

At times, the anchor tenant is situated on property owned by a different owner than the rest of the stores in the center. The anchor is then known as a “shadow anchor.” While the landlord of the ancillary tenants does not collect rent from the shadow anchor, he still has all the advantages of the anchor in terms of a draw of consumer traffic.A landlord typically looks for at least one anchor tenant or for credit tenants to occupy 40 to 60 percent of the property. The income of the anchor or credit tenants normally covers all the costs of operating the property. Today’s prime example of both an anchor and a credit tenant is Wal-Mart. Wal-Mart is a famous name and thus a draw for consumers and other businesses to the area, and is rated AA by Moody’s (see Appreciating Concepts).

Appreciating Concepts: Basics of Rating

Three major agencies deal in credit ratings for the investment world. These are Moody’s, Standard and Poor’s (S&P’s), and Fitch IBCA. These agencies provide rating systems to help investors determine the risk associated with investing in a given company.

Long–term credit ratings are denoted with a letter: a triple A (AAA) is the highest credit quality, and C or D (depending on the agency issuing the rating) is the lowest or junk quality. Each rating is further divided into degrees. Depending on the agency, these are denoted by either a plus or negative sign or a number. Thus, for Fitch IBCA, an “AAA” rating signifies the highest investment grade and means a very low credit risk. “AA” represents very high credit quality; “A” means high credit quality, and “BBB” is good credit quality.

The chart below gives an overview of the different rating symbols that Moody’s and Standard and Poor’s issue:

Anyone who owns or is considering renting out a property can benefit from increased awareness of the different types of tenants, as well as strategies to mitigate risk factors associated with investing in rental properties. As capitalists, knowing how to recognize the differences between profitable prospects for your business and riskier ones is essential for success. 
If you’re ready to take the next step in finalizing your investment goals, contact GPARENCY for assistance when dealing with potential tenants. With their combination of expertise, resources, and market insight, they are sure to provide you with a comprehensive tailored experience to satisfy all of your commercial real estate needs.

FAQs:

1. Why do anchor tenants pay less?
   • An anchor tenant is typically a large and well-established retail business that occupies a significant portion of a shopping center or mall. Because of their size and popularity, anchor tenants often have greater negotiating power with landlords and are able to secure more favorable lease terms compared to smaller tenants.
     
     One reason why anchor tenants may pay less is that they can bring in a large amount of foot traffic to the shopping center or mall, which benefits the other tenants as well. Landlords may offer lower rents to anchor tenants as an incentive to attract them to their property and keep them there, because they know that the presence of an anchor tenant can help drive sales for other tenants.
     
     Another reason why anchor tenants may pay less is that they often sign longer-term leases than smaller tenants, typically ranging from 10 to 25 years. This gives the landlord more stability and security, which can also lead to lower rents for the anchor tenant. Additionally, anchor tenants may be responsible for maintaining and operating certain common areas within the shopping center or mall, which can also result in lower rent payments.
     
     Overall, the lower rent payments for anchor tenants can be seen as a mutually beneficial arrangement for both the tenant and the landlord, as it helps to attract more customers to the property and provides stability for the landlord.
2. What are the benefits of having shadow anchors?
   • Shadow anchors are businesses or entities not located within a shopping center or mall but can still provide a significant amount of traffic or draw to the property. Some examples of shadow anchors may include major employers, educational institutions, or popular tourist attractions.

There are several benefits to having shadow anchors for a shopping center or mall, including…

• Increased foot traffic: Shadow anchors can draw in a significant amount of foot traffic to the area surrounding the shopping center or mall, which can help to increase the visibility of the property and attract more customers.
• Greater consumer spending: With more foot traffic comes greater consumer spending, as shoppers may be more likely to visit other stores within the shopping center or mall once they are already in the area.
• Diversification of tenant mix: Having a mix of shadow anchors and traditional anchors can help to diversify the tenant mix within the shopping center or mall, which can attract a wider range of customers with varying interests and needs.
• Increased property values: Shadow anchors can help to increase the overall value of a shopping center or mall, as they can create a more desirable location for both tenants and customers.
• Reduced vacancy rates: With increased foot traffic and greater consumer spending, there may be fewer vacancies within the shopping center or mall, as tenants may be more likely to stay or sign on for longer lease terms.

Overall, shadow anchors can provide a range of benefits for shopping centers and malls, helping to increase foot traffic, consumer spending, tenant mix, property values, and reducing vacancy rates.