Financial Due Diligence of the Tenant The #1 Imperative for all Tenant Brokers

First let’s start with the definition of “ Due Diligence”:

“Due diligence is the process of systematically researching and verifying the accuracy of a statement. The term originated in the business world, where due diligence is required to validate financial statements”.

This is the essence of what the tenant rep broker needs to do with their client. Clients come in all sorts of business types, ownership formats, large or small, start-up and seasoned. The tenant rep broker finds their client/customer in a variety of ways. Some are through referrals, or Property Signs, websites, mailings, networking, and cold calling to name the top methods.

The real question for the tenant rep broker is “How well do you really know your client?” 

That question alone should give everyone pause and think about the answer thoroughly. It is not as easy as one thinks.

The role of being a “Tenant Rep” is what exactly? Answer; to find the client commercial real estate space that fits their business operation at the best possible rental rate and for the most favorable business terms subject to the current state of any given market, correct?

And what in addition is the “Tenant Rep’s” role within this process? 

Is not to be the advocate for the client/tenant, trying to negotiate with a landlord based upon certain facts about the tenant which will drive certain landlord business decisions?

It’s a complicated process as any “Tenant Rep” broker will admit, if they are doing their job properly.Yes I realize this post seems to be aimed at the Rookie Tenant Rep Broker. That said, even veterans of the CRE Industry sometimes make missteps in their initial handling of the client, Mistakes allow us to remind ourselves to stick to the proper protocol and business processes which have made us successful in the first place.

We all need a reality check and a reminder every once in a while, realizing that emotions and wanting to help a client should not override doing business the right way!

Can we be lulled into complacency and trust based upon intuition? Yes of course, however, it is never a good idea to begin representing a client in which you really don’t know much about, and certainly don’t know about their financial situation. Even the Large “Too Big To Fail” companies need to be scrutinized.

Look at the present state of the retail real estate market, large Iconic retailers are on the verge of going out of business or are having major financial difficulties! Who would have thought that in 2007 GM would go bankrupt and need a government bailout as it was at one time the #1 Company on the Fortune 500 list! Who would have thought Macy’s and several other major Retailers would be having such financial problems just 5-10 years ago?

So what is the point of this reminder;

It is imperative that all “Tenant Rep” brokers conduct their due diligence on their clients. The client more times than not will be a private company, if you are like me who primarily represent small business owners, they are either sole proprietors or LLC’s. The due diligence that is being highlighted here is about the Client’s Finances plain and simple. There is of course additional vetting that needs to done, which can be obtained by asking a few pointed questions of the client.

Without knowing in detail what the financial status of the client is…

DO NOT PASS GO!

After the first “interview” with the client, (and yes your first conversation should be taken as an interview because you are taking on a JOB, you are being hired by the prospective tenant), you want to know if you will have the ability to even have a viable client that meets all the financial parameters or benchmarks that will be needed to move forward. If you do not know, you as the “Tenant Rep” broker are setting yourself up for wasting a lot of time.

Time is the one true currency that brokers have and cannot squander.

Tenant Rep Brokers do not get paid until a lease is fully executed.

There will be no lease if and when the landlord asks to see the “Client’s” financials along with their business plan, and behold, the financial statements don’t support the financial obligations required of the tenant by the landlord. If they are an unknown company or a start-up, it doesn’t matter; you absolutely need to find out if the Client has any or no tangible assets of any kind to support the lease transaction. You need to know if the client has enough cash on hand to pay the security deposit and first month’s rent as well as have enough money set aside for working capital to sustain themselves for up to 6 months, as the old saying of “If you build it they will come” is not true or close to reality. The client needs to be educated about the rent structure such the “additional Rent” landlords charge tenants, especially retail tenants. They need to know what lease provisions they will monetarily be obligated to pay, such as HVAC replacement. These all add up and they need to know and fully understand what their “Financial Liabilities will be.

In the retail CRE sector most if not 98% of landlords will want a personal guarantee of the lease along with the security deposit and first month’s rent. If the tenant/client cannot step up financially, the landlord will pass. It will also make you; the Client’s advocate, look really bad and be looked upon as unprofessional. Remember as our Parents used to say, “You are Judged by the Company you keep”.

Although you may have had a wonderful initial conversation with your new Client, you really don’t know much about them from a financial perspective. They may have said all the right things and answered all your preliminary questions to your satisfaction, but until you “The Tenant Rep” see what they look like under the hood, you are pretty much in the dark.

This can happen even with a seasoned business that is looking to move. Why are they moving, what’s their motivation (As you know moving of any kind is a royal pain that everyone looks to avoid if at all possible) There may be very good reasons for the Client to be looking to move, that said, make sure they aren’t moving because they are delinquent on their rent or are having financial difficulties.

There is nothing improper about asking the Client for their financials.

It is a sensitive topic that said, you cannot ignore the question or request to see their financials, no more than a lender must ask to see the borrower’s financials or tax returns. You can offer to sign a confidentiality and non-disclosure agreement, limited only to you and others, such as the landlord to see. Of course if the tenant is looking for a loan as part of the transaction that will be between the client and their lender.

You can provide the client with plenty of generic financial forms you can find on-line, and the client can fill them out by themselves. Alternatively, you can ask to see the first pages of the last 2-3 years of their tax returns or if they have an accountant, they can ask for their accountant to send you one of the above.

If you DON”T ask early in the process you have dropped the ball and it will come back to bite you, it always does.

Even if you have known the client for a long time, maybe you actually leased them CRE space, when was the last time you fact checked their financial situation?

One last aspect of doing proper due diligence, if you are Representing a retailer, especially a restaurant client, not only do you seriously need to know of their financial situation, you need to look at their Yelp page and look at their restaurant’s ratings trend line. If you see it is 3.5 stars and above that’s Good.

If you see the trend has gone below 3.5 stars or even lower or never had gotten to at minimum 3.5 stars, and there is enough of a critical mass of reviews, that is a sure sign things are not what they seem and is usually a Big Red Flag. Lastly, check the restaurant’s website, making sure it is up-to date and the information is correct, that the menu reflects current food offerings and make sure you actually visit the restaurant and have a meal there.

Unless it is a Franchise, and even then, you need to check all the above as Franchise restaurants in a particular system are not all the same, and that applies to fast food systems as well.

The following are some additional vetting questions to remind yourself to ask upon initially speaking with your client. These questions will allow you to gain greater insight into your client and their financial capabilities depending upon how the questions are truly answered.

  1. “How much space do you need and why or how have you determined this?” Pretty simple enough question…
  2. If they are currently in business and occupying space and after you have asked, “How much space do you occupy?” more importantly is to ask… “Why are you looking to move?” For all you know they are just shopping the market because they are soon to be renewing their current lease and are using you to get an idea of what their renewal rental rate should be. I would trust if you find out this is indeed the case, you would pivot and ask “Why not have me negotiate your renewal, as whom better than me knows the market!”
  3. If they are a start-up or even a seasoned business looking for the first time to lease CRE, they may have no idea how much space they need. If they pop a number at you, you better ask how they arrived at the square footage calculation. It will depend of course what type of CRE space they are looking to lease.

Before you say great, I’ll send you out a survey right away based upon only the above answers; you have missed an important question. “How much in rent are you looking or willing to pay?” Or how much are you paying currently? Are you aware of current market conditions? They offer you a dollar amount usually in monthly terms…again depending upon the type of space they need, the real question is “How did you arrive at that number?” If they are leasing space now, it is still a legitimate question, because when last did the business owner go out and research the CRE market? Maybe they have spoken to a few brokers based on calling them off their property signs. It still really does not answer the real question of …

What Can the Tenant Afford? The only legitimate way of knowing is looking at their financials.

This is where knowledge of their financials is key. The client may have an unrealistic view of the market. Maybe they talked to a business friend, maybe they want to be in a high rent district and think they can find space at much lower rents than exist? Or they really can’t afford to be in certain geographic areas they say they are interested in. Maybe they are running away from a problem with their current landlord. Needing more space may be their answer, and again the question is “So how much has your business grown revenue wise by percentage? Have you added that many new employees to such an extent that you’ve run out of space, wow you must be killing it!” or” is it possible you can reconfigure your current space?” “Have you spoken with your landlord about moving within the building you are in?”, provided there is enough space to accommodate their expansion needs. (Yeah I know re configuring their current space doesn’t make you any money, but then again, are you properly servicing your client’s needs or just looking out for yourself?) Lastly, you should always meet a potential Client/Tenant at their place of business. This will allow you to assess for yourself what is going on with this perspective client. You know all the outward signs!

What needs to be an absolute imperative to be successful and not waste anyone’s time, especially your own…

YOU NEED TO KNOW YOUR CLIENT’S FINANCIAL DNA.

And if you are a Landlord Rep you may want to learn even more about a tenant looking to lease space within your building. Some landlords run a Credit/ Public Records Check on the perspective tenant (individual) or their business.

As a tenant rep you may also want the same information. What if it is found that the owner of the business in which you are representing has a bad reputation which can range anywhere from Financial issues to Criminal Problems? You need to know, it is not much different than property rep brokers needing to do due diligence on the property they represent.

Too many times we go off all excited, Yay we have a lead to work on, but always keep in mind, they are only prospects (suspects some would say) until you have properly vetted them FINANCIALLY!!!