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LANDLORDS SCRUTINIZE TENANTS’ FINANCES MORE CLOSELY

By Steve McLinden

There are but so many “national credit” tenants to go around. Once landlords get past the roughly 35 percent of national retailers that ratings agencies dub investment grade, the pickings get slimmer and the credit decisions grow more crucial. In fact, with many tenants priced out of centers by rising pass-along expenses, questions of who makes the final tenant roster and why have never been more important to a project’s long-range success, observers say.

Not surprisingly, landlords are devoting more resources to this pivotal risk management strategy. The Macerich Co. uses teams of asset-management staffers to review even the best of the best, its top 15 publicly traded retail tenants, says Bob Williams, the firm’s senior vice president of development and leasing. The research is even more thorough for potential tenants rated below that magic investment-grade mark of BBB-. A team will grade these tenants on a risk scale from 1 to 10, and the company then weighs that against the retailers’ perceived importance to the center’s merchandising plan, says Williams. Some Macerich reviewers focus exclusively on a single category, such as luxury tenants, restaurants or Hispanic-oriented retailers.

At General Growth Properties, such credit checks are done in the financial services department, by staffers who split their time between these and other credit projects, says Robert A. Michaels, GGP’s president and COO. For such regional mall owners, the risks are lessened by the fact that 90 percent of the tenants are national. “These tenants are probably in the best financial condition we’ve ever seen,” said Michaels. “We’ve really had the ability to pick and choose.”

Michaels says the Internet has streamlined the credit-check process, particularly with public companies. And the firm’s financial services staff devotes much more time per screening than ever seeking fiscal data on regional and local tenants, particularly restaurants. “If they’re leasing for seven to 10 years, we want to take a pretty good look at them,” said Michaels.

Some landlords outsource the credit-check function to property managers or leasing agents, while others split it between staff and outsiders, says Cynthia Shelton, director of investment sales at Colliers Arnold, in Orlando, Fla., and a former REIT executive. Equity One hires credit personnel to man the satellite offices it opens in those areas containing the highest concentrations of its properties.

Though smaller tenants pose a greater risk, diligent digging can unveil some gems, says Mez Birdie, director of retail investment services at Maitland, Fla.-based NAI Realvest and a former portfolio manager at Commercial Net Lease Realty. In the case of mom-and-pop shops and regional retailers, “you’re much better off doing your own research through the credit bureaus,” he said. “But what you really want to review very closely is the business plan.” Birdie says he has found that rents must generally not exceed 7 percent to 10 percent of retail sales, or 5 percent to 7 percent of projected restaurant sales, though jewelers and similar high-margin retailers are an exception. Regional retailers, who by definition must have 30 to 50 stores in one region or state, are more eager to share financials than nationals, because the former are usually primed for growth. Birdie recommends asking regionals for audited financial statements going as far back as five years.

NAI Realvest, which performs credit checks as part of its role as leasing agent, is especially careful to determine whether the entity named on the lease is the parent company, a subsidiary or merely a limited liability corporation. “LLC’s usually don’t have meaningful financial support behind them,” he said.

When CVS bought the Eckerd chain a few years ago, it converted the leases for such smaller entities to reduce risk, Birdie says. In fact, retail consolidations have become so prevalent, he says, that some landlords have had to puzzle out the identity of the actual tenant when a lease was broken and legal action became necessary.

Additionally, landlords are well advised to look into any buyout rumors as they complete a credit check, says retail consultant Sanford Goodkin, of Sanford R. Goodkin & Associates. “With so many retail chains getting gobbled up by others, the smart shopping center owner-developer can’t afford to take these things for granted,” Goodkin said. “With this velocity of change, there’s much more doubt about the survivability of almost any tenant. Today’s national credit tenant … may be tomorrow’s missing tenant.”

Indeed, “street cred” does not always a great tenant make, center owners say. Nationals frequently have lease requirements that can leave smaller landlords vulnerable over the long term, says Andrew D’Jamoos, vice president of The D’Jamoos Group, a family-owned development firm in Naples, Fla. “We look at those very, very carefully, especially when it comes to the [retailer’s] right to assign leases, because it might compromise the integrity of the center,” said D’Jamoos. The firm is currently building a large, mixed-use, Brazilian-themed community in its hometown called São Grato, as well as the planned, $300 million Estero on the River, which will contain some 63,000 square feet of retail and restaurants.

With riskier tenants, D’Jamoos typically requires a longer lease, a higher security deposit and the legal guarantee that an individual owner will pay from personal or other assets should the business fail to meet obligations. D’Jamoos knows that the type of retail tenant he specializes in involves greater credit risks. “We need to give people something they’ll come back to, not your average strip retail, so we’re much more protective of the entrepreneurial spirit,” he said. Large chains “don’t go out of the box very much,” he said, not even in resort areas. Even national salon, cleaning and similar service chains, though more immune to credit problems, must often adhere to stock interior and exterior architectural plans that do not fit a D’Jamoos center, he says.

Birdie says industry semantics can be deceptive in the tenant-screening process. “People loosely apply the term ‘credit tenant.’ For some it means at least investment grade, for others, it means a certain net worth, and to some it just means they are publicly traded,” he said. “Don’t be fooled by terms.”

At some firms the credit checking responsibility falls to just one person. Port Washington, N.Y.-based Cedar Shopping Centers, for example, an owner-developer of mostly grocery-anchored centers, entrusts these duties to its vice president of leasing, Nancy Mozzachio. She says lenders focus almost exclusively on the credit status of Cedar’s anchors rather than on the support tenants.

As with any process, there are dos and don’ts. A landlord could get away with demanding a deposit equal to between one and six months’ rent from local and regional tenants, but not necessarily from the nationals, Shelton says. “You have to know who you’re dealing with,” she said. “For example, Best Buy would think you’re crazy if you asked for a deposit.”

Often the credit equation boils down to relationships, says Williams. Tenants with good track records in other Macerich centers are more apt to get the benefit of the doubt. There are other exceptions as well. “If there’s a great tenant getting started and we really like what they’re doing, this can outweigh some of the credit issues,” Williams said. “If we need strength in a category the tenant provides, then we may be a little more flexible.”

Credit checks are not important only to the initial leasing phase. “It’s an ongoing maintenance issue,” said Mozzachio. “We find we have to remain up to date for refinancings or restructuring in our borrowing.” Birdie concurs. “At the end of the day,” Birdie said, “tenants with proven credit are a very critical function, because they have a direct impact on the rating of the center. The higher the rating, the better the cap rate and the better the investment.”