January 02, 2014
When performing landlord and tenant due diligence, the fundamental question that a landlord should ask itself with respect to each tenant is: “Given the financial state of the tenant, the tenant’s payment history, and the state of the tenant’s industry, are the collection techniques adequate to ensure that my necessary cash flow will be maintained?” To do this, the landlord looks at both its own financial state and the tenant’s financial state.
A landlord should always have a clear idea of (i) how tenants’ payment histories (amount of payments coming in each month, current status of delinquencies, etc.) are affecting its cash flow and, in turn, (ii) how much it relies upon its tenants’ payments to satisfy its own obligations (such as debt service, overhead or equity returns). A landlord should always have all tenant accountings up to date, monitor those accountings on a regular basis, and keep tabs on when any special tenant payments (such as property taxes and construction costs) come due.
As tenants begin their economic recoveries, landlords should determine how much each tenant’s actual financial condition has improved, if at all, in relation to how much it deteriorated. Of course, such determinations can never be exact, and in making such determinations the landlord will likely need to rely upon the advice of outside counsel and the landlord’s own instincts and past experiences. However, making these determinations will help the landlord form the criteria it will need when deciding whether or not to utilize a collection technique against a tenant and when to use such collection technique.
Many leases contain covenants requiring a tenant to provide the landlord with yearly or quarterly financial statements which the landlord can use to determine whether patterns exist with respect to its tenant’s financial condition. A landlord should also take the time to re-familiarize itself with each tenant’s business, particularly if that business is part of an industry that has shown significant decline or growth over time. The landlord may want to obtain third party information about the tenant and its industry (such as Dun & Bradstreet reports, SEC filings, and Hoover reports), focusing in particular on the future of that industry. In conjunction with its review of tenant’s industry, the landlord may also want to look at tenant’s historic sales data (keeping in mind how dated such data may be, especially in light of tenant’s industry reports).
FREE Real Estate Training from Lorman
Lorman has over 37 years of professional training experience.
Join us for a special white paper and level up your Real Estate knowledge!
Due Diligence Checklist for Commercial Real Estate
Presented by Larry N. Woodard
Once a landlord has familiarized itself with a tenant’s financial condition and the projected state of that tenant’s industry, the landlord should then re-familiarize itself with the collection techniques set out in that tenant’s lease to determine whether the collection techniques are adequate to ensure that its necessary cash flow will be maintained.