If you own a shopping center then you know that high occupancy rates and stable tenants are vital to the success of your asset. Many owners of neighborhood, community, and regional centers believe that having at least one credit tenant on the rent roll will ensure a stable rental income and high occupancy. In some cases this may be true; a nationally recognized name can attract a steady stream of shoppers that will support smaller tenants and help you lease your property. However, a national credit tenant is surprisingly not the best option for all retail properties.
What is a national credit tenant?
By definition a credit tenant is a tenant that was awarded an investment grade rating based on its size and financial strength. Moody's, Fitch, and Standard & Poor's are the three major credit rating agencies. An investment grade rating is significant to property owners because it indicates that the tenant will most likely have the means to continue paying rent, even in a volatile economy.
What are the benefits of leasing to a national credit tenant?
One of the incentives for leasing to a credit tenant is financing. Typically a development with a certain amount of space leased to a credit tenant will receive better financing terms from lenders. Cheaper financing can save tens to hundreds of thousands of dollars over the life of a loan. Credit tenants on the rent roll can also influence lenders to refinance your loan in the future.
National credit tenants can also impact the occupancy (and revenue) of a shopping center. They tend to attract shoppers, spend more on advertising, and their nationally recognized names can lend credibility to the asset. In many cases, a credit tenant is a destination retailer which means that shoppers are willing to drive a longer distance specifically for that tenant. Most property owners wager that the shoppers will likely visit ancillary stores during their trip as well. The promise of increased traffic will probably attract other tenants to lease space in your development.
"Credit tenants may seem like the ideal choice," said Jack Rose, Chief Strategist at Breakwater Equity Partners, a commercial real estate advisory. "But surprisingly in some cases, a credit tenant may be more detrimental than valuable. Shopping center owners need to understand all of their options."
What are the risks to leasing a national credit tenant?
The clout of a national credit tenant often puts them in a position to demand lease concessions that would otherwise not be considered. One example is a "non-operation" clause or an "open for one day" provision. This clause gives the tenant the right to open for business when and if it chooses. As the owner of a retail development you may not see any immediate potential for harm with this clause. Let's consider an example. Your community center in Phoenix, AZ is anchored by a Ralph's grocery store. Last year Albertson's built a brand new store right across the street. Shoppers flock to the new store, and Ralph's is actually losing money every day that it remains open. The Ralph's corporate accountants crunch the numbers and decide it will be cheaper for them to pay the rent on an unused space than to continue to do business at that location. While that may be a good business decision for Ralph's, the vacant grocery store space could decimate the traffic to your development. All of the other tenants in your development may begin to suffer as less shoppers drive into the shopping center.
Another risk of leasing to a credit tenant is the tenant-improvement investment that you will most likely make. Leasing a credit tenant is often a considerable investment. In addition to hefty tenant improvement and leasing commission fees there may be additional rent abatement concessions made as well. This cost of doing business with a national credit tenant may or may not be justified by the higher and more dependable rental rates.
Credit tenants often request a lengthy lease term. This may sound desirable, but today many property owners are now regretting the long-term lease that they signed during the Great Recession. If your property is in an improving or growing market, then rental rates may be increasing in the next few years. Locking yourself into today's rental rates may not be your best option.
How can I make the best decision for my property going forward?
Shopping center owners should not capitulate to the demands of a national credit tenant under the assumption that a lease with a credit tenant will be the best strategy for the property. Before entering into a lease that will have a substantial impact on the viability of your property, it is important to evaluate the terms and model out the potential long-term benefit to you as the property owner. If you do not have access to a financial modeling program or extensive financial modeling experience, then you may need to consult a commercial real estate advisory firm to make the best decision for your property.
"Don't assume that a credit tenant is your best option," said Rose. "Negotiating the optimum deal for you and your property may require some patience, and it will definitely require a methodical analysis of your property's finances. If you cannot obtain an economically viable deal from a national credit tenant then entering into a lease with a local or regional tenant may be the better strategy."