Purchasing your investment property is only half the fun. You still have to consider tenant selection. What, that doesn’t sound fun to you? Commercial tenant selection can be a tedious process, but it’s important that you give it your full attention and take your time to secure the right fit. Let’s explore what you need to keep in mind as you search for the tenant that will foster a long, lucrative relationship with you and your investment.
Why Careful Commercial Tenant Selection is Crucial
Selecting the right commercial tenant for your property directly correlates with the profitability of your investment. You’re looking for a tenant that will maximize your yields while keeping your risks at a minimum.
You may be tempted to hustle as quickly as you can through tenant selection. After all, you’re losing money for every day your property remains vacant. But keep in mind that commercial leases often last longer than residential leases. The average commercial lease runs for three to five years with an option or two to exercise. Since a commercial lease can run for years, you’ll want to consult with a real estate agent to hammer out appropriate lease terms for each client.
Putting real effort into tenant selection not only pays in the long run but can also protect you from legally tying yourself to a problematic tenant. Covenant strength, a legal term that indicates the likelihood that lease terms will be sufficiently honored, needs to be at the forefront of your mind throughout this process.
There’s a gulf of difference between a lengthy lease with the right tenant and a lengthy lease with a nightmare tenant. Do your future self a favor. Take the time to get it right the first time!
The Ideal Commercial Tenant
The ideal tenant will differ from property to property, but there you can seek out a few universal traits when trying to fill a vacancy. For one, you want a tenant with a history of punctual payment. After all, choosing a tenant who pays their rent on time is investment 101.
You’ll also want a tenant with a history of keeping properties in decent shape. Naturally, a bit of wear and tear and even some light renovation is to be expected with long-term commercial leases. But some tenants are simply more considerate of property than others. If you need a bit of extra insurance, consider collecting a deposit at the beginning of the lease. Deposit amounts vary depending on the tenant’s intended use for the property and the estimated resulting wear and tear.
Finally, look for tenants who have frequently renewed or maintained their leases. Selection of a commercial tenant is an involved process; one that you won’t want to repeat every year. Consider the strength of their business, how passionate they are about what they do, and how interested they seem in your investment property. Ideally, your new commercial tenant should usher in the start of a long and lucrative relationship for both of you.
The Financial Considerations of Tenant Selection
We can get more concrete with the financial considerations you should diligently explore when vetting a potential commercial tenant. These will vary depending on the type of business structure applying for tenancy.
Established Businesses
If a business is reliably established, they will have plenty of financial records for you to peruse. Request the following from any established businesses:
- Records indicating revenue stream
- Tax returns (at least two years’ worth)
- Profit and loss statements (again, at least two years’ worth and preferably certified)
- Financial reports (year-to-date)
Startup Businesses
You’re taking on more risk with a startup than an existing business, but every success story started somewhere. You’ll just need to exercise diligence when screening startup companies by requesting:
- Credit checks
- Personal bank statements
- Security deposits
- Owner guarantee (this is optional, but a written personal guarantee from the owner can add another degree of security)
Limited Liability Corporations (LLCs)
It’s easy to feel confident when considering an LLC for commercial tenancy, but you’ll still need to review their application carefully. As for financial statements, it’s up to your discretion. If you want greater peace of mind, request an official personal guarantee. Double check that all financials show the name of the legal entity applying for tenancy.
Finding the Right Fit
You know what you want from a commercial tenant. But for long-lasting, happy relationships, you also need to consider what your tenant wants from your investment property. And, on a deeper level, how your prospective tenant’s vision fits into the community landscape of your property.
When a tenant states their intention, ask yourself if it’s the right fit. Obviously, a nightclub may not be the best type of business to squeeze between a daycare center and a pet grooming salon. If you’re having trouble deciding for yourself, take into consideration your city’s zoning and local restrictions.
Understanding a Commercial Tenant’s Expectations
When you’re comfortable that your potential tenant’s business will complement other area businesses and the character of the community, you’ll need to review whether they’re planning any renovations. Does your property already meet all of their needs? Or will they want to significantly change the structure to accommodate their vision? Changes could impact your lease terms, not to mention your property management responsibilities for years to come. Make sure that both you and the applying tenant fully understand what to expect from one another.
Know Your Competition
You also need to know your competition, because your property is likely not the only one your potential tenant is considering. How do you compare to similar commercial properties in your area? Think about the following points:
- Tenant necessities – can your property satisfy or even excel beyond their needs?
- Amenities – are there any tenant amenities that you need to add to stay competitive?
- Unique features – what does your property offer that your competitors’ properties don’t?
Marketing to Your Ideal Tenant
If you haven’t had any applications for tenancy yet, you’ll want to develop a tailored marketing approach for your ideal commercial tenant. Consider working with real estate experts who understand the kinds of photos and copy that command the attention of your preferred type of tenant.
Trust a Professional
The role of a commercial real estate agent in tenant selection can’t be overstated. An experienced agent will represent your interests while ensuring a commercial tenant is happy as well, recognizing that a win-win scenario is integral for a lucrative, long-lasting relationship. If you need vendor or property management recommendations, they will be able to provide you with multiple trusted resources.
Ways a real estate agent can assist in the search for a commercial tenant include:
- Networking
- Marketing (including digital marketing)
- Physical promotion (such as onsite signage)
There’s no way around it; commercial tenant selection is an involved process. But it doesn’t have to be painful. Explore the steps above, take your time to get it right, and, if you need assistance, reach out!
