Commercial Landlords: Do Your Due Diligence

As a landlord, you want to ensure your tenants can afford the rental amount throughout the entire lease term. Commercial landlords can be reluctant to ask potential tenants for financial records, but a landlord shouldn’t hesitate to do so. Although no amount of pre-screening can protect you from every situation (enter COVID-19), by vetting potential prospects up front you’re mitigating potential occurrence of default and, at the very least, outlining the terms of the lease to protect all parties from the unexpected.

Depending upon the type of entity of a potential lessee (ex: LLC, sole proprietorship, S-corp, etc.) and the length of the term, landlords may (and should) ask for the following business documents and financials:

1. Up to two years of profit/loss statements, balance sheets, and taxes
2. Personal financial statements
3. Business bank statements

If you are considering leasing to a start-up business, where they may have no concrete indication of profit, request personal financial statements and tax returns. If a new business’s financials aren’t as strong as you’d like, the tenant may still be a good candidate and you might consider asking for first and last month’s rent or a larger security deposit. You can also request a personal guaranty to assure that contractual obligations can be met by at least one individual on the lease. If there are extensive leasehold improvements to be made to the space, a lessee will need to demonstrate their ability to not only cover base rent, but common area assessments, maintenance, and the tenant improvement amount. This additional burden should figure into your final assessment and determination on leasing to the tenant.

In addition to financial records, other due diligence measures that can give you a sense of a potential lessee’s overall financial picture and ability to satisfy the lease include:

1. Reviewing the company’s business plan
2. Running credit checks on all individuals
3. Checking criminal histories
4. Researching the company’s rental history and inquiring why they are leaving their current space

The amount of due diligence needed varies by the type of space, the amount of rent, and the amount of the landlord’s initial investment (buildout for the tenant). If the leasehold space is generic and the tenant could easily be replaced, the due diligence process isn’t as imperative. However, if the space is customized and the tenant not easily replaceable, it’s even more important to verify that the tenant is financially solvent and capable of supporting the rental amounts.

In real estate, there’s no such thing as the perfect tenant, or landlord for that matter. It’s imperative that both parties conduct their own due diligence to determine if the arrangement is mutually satisfying.

Cassie McGarvey is double Board Certified in commercial and residential real estate law in the state of Texas. Cassie has a unique perspective on the complexities surrounding real estate in the Texas. Contact her at cmcgarvey@mcgarveypllc.com.