PB-142 Check Out Your Tenants - Property Inc

[ Podcast Transcription ]

I’m Peter Boyle McNiss, and he is Chris Lang, and welcome to another of these regular property briefings.

And a warm welcome to you, Chris. Well, it’s, uh, good to catch up with you again. You know, I’ve often wondered how to go about establishing the financial standing of a tenant as the owner of a commercial property. Could you perhaps walk us through what steps investors can take? Well, it’s interesting you ask that because several of my clients have also raised the same issue and there are two.

Situations you need to consider as far as checking tenants out. One is when there’s an existing lease in place. And the other is when the property becomes vacant and you’re seeking out a new tenant. Now, if it’s a new tenant, you can carry out credit checks, but there’s a limit to the amount of research you can actually undertake because With the current privacy laws that are now in place, there’s a fair protection as to the amount of information that’s a little bit easier with commercial property than it is with residential.

As I said, if it’s a new tenancy, quite often you can ask for a. A letter from the tenant’s accountant providing with a track record of their past couple of years trading and a comment from them as to their capability of meeting their financial commitments under the new lease. You find accountants are a little bit coy about doing that in case they leave themselves open to some sort of, you know, illitigation.

Going down the track if, for whatever reason, the tenant doesn’t perform. Again, you can do a professional credit check that’s, you know, through Dun Bradstreet or one of those service providers. Unless the tenants have been in default of a loan or have had a court judgment against them, you’re probably not going to discover a hell of a lot.

I mean, they’ll give you a, a profile list of the shareholding and… How long the company’s been in existence, but there’s a limit to, again, the information that can be provided, notwithstanding that some of those reports might run into five or six pages. When you really boil it down, there’s not a lot of substance that you can hang your hat on.

So. It’s a little bit difficult, particularly with newly formed companies and most with commercial property, most of them are going to be in the name of a company. So it’s probably trying to gain a track record through their past, how long they have been in business, where they were before. If they’re a reasonably well known company, you might get some press coverage.

So just a search on the internet can quite often turn something up. So, as I said, it’s a little bit difficult, but you’ve just got to do the best research you can. You also mentioned the situation where you were buying a property with the tenant already in place. Yeah, that’s the second alternative. And again, you know, a credit check may bring that up.

That’s one of those Dun Bradstreet ones, but as I said, you’re limited. With an existing tenant, probably what I would suggest to you is that the best way to approach it is to talk with the managing agent, which may or may not be the selling agent. But if you ask the managing agent, To provide you with a rental payment history for at least the last six months and that’s intended to establish whether or not they have been in arrears with their rental or owners corporation payments or rates or anything else that they’re liable to pay under the lease and quite often the property manager particularly if you indicate that If you’re going to purchase the property that you would intend to keep them on, we’ll be cooperative and yeah, they may even volunteer some things like, you know, two years ago, we, there was a problem that the financial controller died and they fell behind, but.

As soon as they got back on track, they, you know, paid the first of the month or pretty close to it ever since. So, quite often you’ll get some informal feedback you couldn’t otherwise get through official channels. So, again, you’ve got to do the best research you can. And I mean, that’s the sort of thing.

I try and do it on behalf of clients and there are market sources with certain tenants. You hear about them, other agents will talk about them. I mean, I have clients of mine who will ring me up and let me know about bad experiences they’ve had with various parties to the transaction, more just so I’ve got that as background knowledge so if I’m ever dealing with them, I’m forewarned.

So. As I said, it’s just having access to this market intelligence, which I find perhaps easier to obtain with the network of agents that I deal with. But nonetheless, as I said, if the property manager believes he or she is going to continue on managing the property if you buy it, generally they’ll be pretty forthcoming and give you a reasonable background as to the history.

Apart from the tenant’s payment history, what other aspects should you be considering? Yeah, look, as I said, knowing the payment history is helpful, but one of the things that I like to focus on is whether the lease provides for a rental guarantee. As part of the terms and conditions of the lease and I generally like to have a guarantee for the rent and outgoings NGST for a period of time.

Now, just as a guide, what I generally advise clients is that for a three year lease, you should have a three to four month rent guarantee in place. For a five year lease, you should have five to six months. And for an eight to 10 year lease, probably a 12 month rent guarantee or bank guarantee is what we’re talking about.

So it’s not a security deposit. I think. The ideal thing is a bank guarantee. Now, what’s interesting is that quite often, as I said, you have new companies now setting up, there’s a lot of new businesses where they may have sold out of another business, or there’ve been a couple of. Employees of another business that have made good money in that business and they’re pretty cashed up and now looking to set up by themselves and they will have a lot of consulting contracts even back to the same company they’ve left, but they have through their network got a good clientele that they can pick up and run with straight away.

And as I said, generally they’ve been earning good income. So they’re cashed up. They may have assets. So from their point of view, they don’t have a track record by themselves. They might have from a sales point of view, but not a corporate trading point of view, but that’s not really that important.

What’s important. If you can get a six or a 12 month bank guarantee out of them, and they’re more likely to give you that, because as I said, Not only might they be cashed up, but they probably have assets. They probably have a very nice home or even a beach home or something like that, against which they can provide you with a cash bank guarantee.

So that gives you the security of knowing that If for whatever reason they do default on their lease, that you’ve got access to cash and therefore limits your exposure. So just because someone doesn’t have a track record is not a reason to lessen your view of them as a corporate entity, either in an existing lease when you buy the property or as an incoming tenant should the premises, um, in fact become vacant.

So, as I said, your focus ought to be on the security of having that bank guarantee in place, as I said, ideally either six or 12 months, depending on the length of the lease, and then you don’t really have to take it or pay as much attention to gaining the credit checks and all those. Other things we just spoke about.

I mean, that’s the traditional way of doing it. But what I find now is a lot cleaner and provides a lot more comfort is having a grossed up bank guarantee, grossed up meaning rent outgoings and, and GST in place as one of the terms and conditions of the lease. What about director’s personal guarantees?

Well, in my opinion, personal guarantees are worthless as far as you’re concerned as a landlord. I mean, the directors of a company now, even though they might give the personal guarantees, You can pretty much count on the fact that they don’t have any assets in their name. They’ve either got them in the family trust or in their wife’s name.

And so yes, you might be able to sue them. It’s not going to make any difference, you know. And you can sue them, but it won’t affect the company. And it won’t provide you with a great result. And in fact, the procedure for suing under a personal guarantee, pretty convoluted and pretty costly as a legal process.

So I wouldn’t even bother with personal guarantees. As I said, your focus should be on, on the bank guarantee. And just so we’re clear, if the tenant defaults and you have a bank guarantee, You have unfettered right to call up that bank guarantee if the tenant defaults on payments under the lease. Now, yes, you can call it up, but you must immediately take what is called action to mitigate your loss.

You can’t simply. take the money and do nothing. You have to take steps to find a replacement tenant. Now the bank guarantee is intended to cover any losses you incur in finding that replacement tenant. So that might be the loss of rent during the time up till finding the tenant. So let’s say you’ve got a six month bank guarantee.

It takes you a month to find the tenant. The tenant wants a couple of months rent free. So that’s three months you’ve had advertising. Which amounts to, let’s say, another month’s rent. So that’s four months. Uh, you’ve got a letting fee, which probably accounts for at least another month or so. So it might be five and a half months worth of loss that you’ve incurred.

Now, if it’s a six month bank guarantee. You can only claim up to your loss, which is in this case, and I’m rounding the figures, all five and a half months. So you then have to return to the tenant the remaining amount over and above your costs up to the six month period. So it’s about, the whole amount is available to you, but you can only claim.

up to the amount of the loss incurred by their default. I mean, that includes legal costs as well. Now, hopefully it won’t exceed the six month period or the length of the bank guarantee. It’s intended there to enable you to move quickly and not having a fear that you’ve got to dip into your own pocket to find the replacement tenant.

So, hopefully that gives you a better understanding. of the way to secure and to analyze and assess whether a tenant is worthy of your investment if they’re already existing or entering into a lease if it’s a brand new letting. Well, that certainly sheds a lot more light on the subject. Well, as you’ll appreciate, it’s not always easy to get a definitive grasp on a tenant’s financial status.

And there’s only so much information that you can obtain, given the current privacy laws. But nonetheless, If you undertake some basic homework and focus more on bank guarantees than personal guarantees, you should come out on top. Anyway, thanks again Chris. I’m sure that has provided some valuable insight for our listeners.