When Great Credit Can Be Bad!

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Every day, well-run companies strive to improve their credit ratings.  Banks search for companies to whom they wish to lend, based on their credit and many other factors.  Investors, landlords, business partners, companies selling products or services, rating agencies, and information consolidators, all spend countless hours analyzing the creditworthiness of companies, searching for the best and often deciding not to conduct business with those companies with poor credit.

So, great credit will put your company in a position of strength, right?  Well?  Great credit and a solid financial footing will certainly open doors that may otherwise be locked.  When acquiring real estate through lease transactions, great credit is what attracts landlords to certain tenants and affords those tenants better terms than their less creditworthy corporate brethren.  If your company has great credit, banks, investors, and others will race to do business with you at lower rates and on better terms than for other companies…right?  Interestingly, the answer is: “Not always!”

When could great credit get in your way?  That same great credit can become a 100 foot high obstacle when companies seek to sublease surplus real estate or assign leases that they no longer require.  With the growing amount of space offered for sublease or assignment, creditworthiness becomes a major issue.

A large focus of landlords is credit risk.  Since fewer and fewer companies actually have great credit these days, when a creditworthy tenant seeks to get out from under a lease by assigning it to another company, landlords will weigh the original tenant’s creditworthiness against that of the potential assignee.  Unless the incoming assignee’s credit matches or exceeds that of the original tenant, the landlord will likely do everything in its power to retain the original tenant in the liability chain and will not readily permit the original tenant to absolve itself of its obligation.  In fact, the landlord may not approve of the incoming tenant or the transaction at all.

From a risk management perspective, the landlord’s actions in this kind of situation are perfectly understandable.  Why would anyone swap bad credit for good credit, especially in the current economic environment where many seemingly good companies are now perceived as risky?

After reading the above, most finance executives considering acquiring real estate through a sublease or assignment transaction would likely start thinking about credit enhancement and additional security deposits.  At a time when sustainable and predictable cash flow is king and the risk of loss is high, additional security deposits won’t mean a thing to most landlords.

Think about it like this:  If a good credit tenant is permitted to be absolved of its obligations in exchange for a riskier tenant, and given that security deposits in commercial real estate transactions typically cover a small portion of lease obligations, what benefit would a landlord derive from any credit enhancement or additional security deposits?  Few, if any, commercial mortgage lenders would even consider authorizing a landlord to whom they lend to agree to replace the good credit of an existing tenant with the questionable or unproven credit associated with an incoming tenant.

How about credit enhancement?  The only way that credit enhancement would alleviate landlord and lender fears of increased risk and possible cash flow loss would be if either the outgoing original tenant or the incoming tenant guaranteed a very significant portion of a lease’s value, if not, the entire lease obligation, and could demonstrate the financial wherewithal to do so.  That’s exactly what most landlords would seek in this instance.  Unfortunately, guaranteeing an entire lease obligation would place the outgoing tenant right back at the starting gate of not being able to absolve itself of its financial obligations.  And, most incoming tenants are unwilling to make such a commitment.

After all, landlords are as much in the business of managing risk as they are in owning buildings, generating cash flow, deploying leverage, and building equity appreciation.  And, that’s precisely what landlords must do in the current economic environment to sustain themselves…manage risk very well.

This is a time, when companies are seeking to relieve themselves of surplus lease obligations, that a tenant’s strong creditworthiness will actually work against it.   In this environment, there are times When Great Credit Can Be Bad.  Alternative approaches to disposing of surplus real estate, including the use of lease renegotiations and other non-traditional approaches, may be a strong tenant’s best bet.

 

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About Real Estate Strategies Corporation
Real Estate Strategies Corporation is a respected corporate advisory and transaction services firm that provides thought-leadership, decision-making, planning, project management, and transaction execution services to finance and senior executives at management team-led public, private, and portfolio companies, and not-for-profit organizations.  Under the leadership of its award-winning CEO, Andrew Zezas, RealStrat’s clients engage the firm when acquiring, disposing of, renegotiating, or enhancing occupied leased or owned real estate in New Jersey, Pennsylvania, New York, Connecticut, and throughout North America.  By creating and executing Business DRIVEN Real Estate Solutions and identifying hidden Opportunities, RealStrat drives greater operational and financial performance in support of its clients’ stakeholder objectives, M&A requirements, and exit strategies.

In the current economic environment, RealStrat’s efforts are focused on uncovering, capturing, and re-purposing hidden liquidity and minimizing risk in its clients’ leased and owned real estate.  The firm provides counsel as to competitive advantage strategies in preparation for the eventual economic recovery.  Visit www.RealStrat.com. Follow CFO Studio at http://www.Twitter.com/CFOstudio.

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