How Landlords Evaluate a Prospective Retail Tenant

A landlord evaluates a prospective retail tenant by answering two questions: can this business pay rent and its share of expenses for the whole term, and does it belong in this center. The first answer comes from the tenant's financials, operating history and the security it offers, and the second from how the concept fits the tenant mix, the parking and the exclusives already granted.

Careful screening is fair to tenants too. One clear request list at the letter of intent stage lets a strong applicant move quickly and gives a newer operator a fair chance to make its case. Below is the review we walk owners through as part of landlord representation, with a checklist at the end.

What financial information should a landlord ask a retail tenant for?

Ask every applicant for the same core package. For an established business, we ask for two or three years of financial statements (a profit and loss statement and a balance sheet), the business tax returns for the same years, and several recent months of bank statements. The statements show whether the business earns enough to carry a new location, the tax returns should tell roughly the same story, and the bank statements show whether there is cash for the build-out, the deposit and the months before sales ramp up.

If anyone will sign a personal guaranty, ask each guarantor for a personal financial statement, personal tax returns and, with written authorization, a credit report. A business credit report on the tenant entity is also worth pulling. Explain who will see the information and keep it confidential. Operators are understandably private about their finances.

Then read the numbers against the deal. Compare a year of base rent plus estimated NNN charges with current or projected sales. A restaurant, a salon and a medical office carry rent differently, so no single ratio fits every use. The question is whether this operator can carry this rent in a slow year. The LOI term sheet builder gives a working read on what a concept can afford.

How do you evaluate a new concept with no operating history?

A first location has no track record, so the file has to show the plan and the money behind it. Ask for a business plan with monthly sales projections for the first two or three years and the assumptions behind them, a build-out budget, and the sources of funds (owner cash, investors, a bank or SBA loan, or a franchisor program). Ask for resumes of the people who will run the store. A manager who has run a similar store for another owner is a different risk from someone new to the category.

Test the projections gently: if first-year sales run well below forecast, where would the cash come from? For a franchisee, ask for the franchisor's written site approval, the term of the franchise agreement and a contact at the franchisor. A thin file is not a reason to decline on its own. It is a reason to match the security package and the allowance to the risk.

What does the tenant's history at other locations tell you?

For an operator with existing stores, that history usually says more than any projection. Visit a store at a busy hour. Ask how long the tenant has been at each site, whether any stores have closed, and why. Call a current landlord, who can speak to payment habits and how disputes were handled. A court records search on the entity and its principals can surface judgments, liens or past lease litigation. If the tenant reports sales to other landlords for percentage rent, ask for copies, since they are an independent record of performance.

How should a personal guaranty be structured?

A personal guaranty backs the lease with the assets of the people behind the tenant entity, which matters most when the tenant is a new company with little on its balance sheet. It does not have to be all or nothing, and tailoring its scope often gets a deal done with a good operator who is uneasy about open-ended exposure.

Common approaches include a cap stated as months of rent or a dollar amount; a burn-off that reduces or ends the guaranty after a period of on-time payment; a “good guy” guaranty, where liability ends if the tenant gives notice, pays rent through move-out and returns the space in the required condition; and a guaranty limited to the owner's unrecovered costs, such as the unamortized allowance and leasing commissions. A parent company can sometimes stand in for an individual. Match the shape to the capital you are putting into the space. Our post on the personal guaranty in a California retail lease has more detail. California has its own rules on guaranties and the waivers in them, so have your attorney prepare the form.

How much security deposit should you ask for, and what does California law say?

The deposit is the owner's first source of recovery if rent stops or the space is left damaged, so size it to the risk. A new concept receiving a large allowance may warrant a larger deposit, a letter of credit, or a deposit that steps down after a period of on-time payment. Our post on the security deposit in a California retail lease covers those options.

Commercial deposits are governed by California Civil Code section 1950.7. The landlord holds the deposit for the tenant, and the tenant's claim to it comes ahead of the landlord's creditors, other than a trustee in bankruptcy. The landlord may claim only the amounts reasonably necessary to cure rent defaults, repair damage the tenant caused, or clean the premises at the end of the tenancy, if the deposit was made for those purposes. The balance is generally due back no later than 30 days after the landlord regains possession. If the claim is only for rent and the deposit is more than one month's rent plus a clearly described last month's rent, the amount above one month's rent is due back within two weeks. On a sale, the deposit must be transferred to the buyer with notice to the tenant, or returned to the tenant. Bad faith retention can bring damages of up to $200 plus actual damages. The section does not set a maximum deposit amount. Ask your attorney how your lease form handles these rules.

Does the concept fit the center and the exclusives already granted?

A tenant with strong credit can still be wrong for a center. Check the use against three things: the merchandising plan (does it add a reason to visit, or compete with a tenant you already have?); its physical demands (peak parking, hours, deliveries, odors, noise and utilities, especially for food users); and the property's restrictions, meaning every exclusive and prohibited use in your existing leases and any recorded limits in a reciprocal easement agreement or CC&Rs. A lease that conflicts with an existing exclusive can give the protected tenant remedies against the owner, so read those clauses first. Our post on the exclusive use clause explains how they are usually written.

Fit runs the other way too. A broad exclusive granted to the new tenant can block future leasing, so keep it narrow. The tenant mix planner compares your current categories with a template for your center type. If the applicant pool for a suite has been thin, the vacancy diagnosis tool can help you see why before you lower the bar.

What changes when a tenant is financing with an SBA loan?

A tenant may fund its build-out with an SBA 7(a) loan. According to the U.S. Small Business Administration, the program provides a guarantee to participating lenders rather than lending directly, the maximum 7(a) loan amount is $5 million, and the borrower must be creditworthy and show a reasonable ability to repay. The SBA's terms and eligibility page lists leasehold improvements, equipment, fixtures and working capital among permitted uses, and says the SBA considers a loan fully secured when the lender holds security interests in the assets the loan acquires or improves.

A loan approval is a useful second review of the tenant's credit, but it does not replace your own. If the tenant needs a financing contingency, set a firm outside date so the suite is not held off the market indefinitely. Because the lender may take a security interest in equipment and fixtures inside your building, expect a request for a landlord waiver or consent covering the lender's access to that collateral. Review it with your attorney, with attention to access, notice, removal and restoration of the premises.

What are the red flags when screening a retail tenant?

None of these is an automatic no. Each is a question to answer before signing. Watch for statements that do not reconcile with the tax returns; an unwillingness to share any financials; a new entity with no guarantor or other credit support; cash that will not cover the build-out and first months of operation; projections well above what the operator's existing stores produce; judgments, tax liens or repeated disputes with landlords; stores that closed early without a clear reason; a use not yet checked against zoning and permit requirements; and pressure to sign before the file is complete. A request for a large allowance, long free rent and a minimal deposit all at once also deserves a closer look.

Give the applicant a chance to explain. A store closed during a long road project, a one-time expense on a tax return, or a first-time owner with years of management experience can each be a reasonable risk with the right structure: a stronger guaranty, a larger deposit, or an allowance paid after opening.

A screening checklist for retail owners

• Send every applicant the same written request list at the LOI stage.
• Collect two or three years of financial statements and business tax returns.
• Check recent bank statements for cash to cover the build-out, deposit and opening costs.
• Get personal financial statements, tax returns and authorized credit reports for each guarantor.
• For a new concept, review the plan, projections, budget, sources of funds and operator resumes.
• For an existing operator, visit a store, call a current landlord, ask about closures and search court records.
• Compare base rent plus NNN with current or projected sales.
• Choose the guaranty scope: capped, burn-off, good guy, or limited to unrecovered costs.
• Size the deposit to the allowance and the risk, and have your attorney check the lease form against Civil Code 1950.7.
• Check the use against every existing exclusive, prohibited use, REA and CC&R restriction.
• For an SBA-financed tenant, set a financing outside date and have your attorney review any landlord waiver.
• Write down the reason for each decision and keep applicant files confidential.

Talk to us about your property

If you have a prospective tenant for a vacancy, or an applicant you are unsure about, we are glad to look at the file with you. Parker & Associates has represented retail owners and tenants across Orange County and Southern California since 1995, and you can read more about how we work with owners on our landlord representation page. Call us at (949) 796-7275 or email leasing@digitalre.com.