This post originally appeared on tBL member blog SVN Southland Commercial Blog and is republished with permission. Find out how to syndicate your content with theBrokerList.

When working with investors, who are interested in a real estate investment, I am often asked the question, “Is this a credit tenant in the space?” Of course to answer that question literally we need to define what a credit tenant is. A credit tenant is a tenant that has a credit rating from one of the big rating services like Moody’s or Standard & Poor’s- BBB, Aaa-, etc. Most tenants do not have a rating. So the question becomes, “How do I figure out if I want to purchase the asset with this tenant or tenants?”

Is a Credit Tenant Worth the Risk?

risky credit tenantThere are multiple things to consider when deciding whether the tenant is worth the risk, but there is one thing that trumps them all. Yes, you can look at the market rents in the area compared to the rents in the investment you are considering, or you can look at the financial statement of the tenant, or look for a longer lease term; however, to quote one of the pioneers of the NNN investing business, Chris Volk of Store Capital, “store sales is the single most important metric, when considering the risk in a retail real estate investment.” Historically a tenant can pay approximately 8% to 10% of the gross sales at a location as occupancy costs. These percentages vary by industry. For example, if the tenant is in a high margin business, like cell phones or mattresses, they can allocate a lot more to rent. However, if you can compare the store sales or rent to sales per unit, and then to industry averages or historical percentages, you will have a wealth of data on how important the unit is to the operator. In other words, if the operator is making money at the location they are very unlikely to leave and the market place has already voted on the location and given it a stamp of approval. Frequently, a medium size operator that has 30 restaurants or tire stores, which are all making money, can generate higher yielding and safer investments than a Starbucks that is paying $50 per sf in rent.

There are multiple things to consider when deciding whether the tenant is worth the risk. Click To Tweet

Location, Location, Location

So, do you need a credit tenant? Not exactly, because the best credit is a location that the market place has already voted on and approved of. If over time the business concept falls out of favor, the landlord will be in a position to re-lease the real estate to the latest hot concept, because the location already has been analyzed and approved by the marketplace.

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About Francis Rentz- Francis, one Francis Rentzof the founding members of SouthLand Commercial, has more than 20 years of experience, and secured numerous transactions valued at more than $100 million. He specializes in commercial properties and land in the northwest Florida market. Click here to view his full profile and listings, or if you would like to contact him, you can call him at 850-877-6000, or email him at [email protected]

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