Tenant Credit Underwriting - How do you look at very small private companies <$10M Equity

RE Dude's picture
Rank: Senior Baboon | 226

For those in acquisitions/capital markets, how are you underwriting small private tenants? What are you looking at specifically? Are you incorporating any custom quantitative models? Any materials/models you could point me too?

Background for question:
I work in NNN/NN retail/office development. Half of our tenants are small private firms or franchisee restaurants. Financials range from everything to financials with tax accounting basis to audited GAAP(ish) statements, sometimes new businesses. At minimum I'm trying to get a few years of P&L and Balance Sheet, then a bunch of follow-up questions to understand tenants operations/experience.

I'm trying to create a standardized process with simple quantitative aspect that my leasing team could use to do initial pass to even decide if they should be spending any time/resources before going down lease route. I'm thinking some simple financial metrics and a few subjective inputs to create a rating say 1-10. If the tenant is decent enough, I'm trying to adjust cap rate I'm underwriting up/down based on comps, say corporate tenant traded at 6% cap, this franchisee needs to be discounted 0.10 - 0.25% (I assign a cap rate to every tenant, to get weighted project cap rate for a direct cap development disposition).

I've read up quite a bit on S&P/Moody's methodology. Concepts are great, but with private companies, I'll never have that level of detail for inputs.

Thanks in advance for any thoughts, there's not exactly a right answer here.

Comments (2)

Most Helpful
Aug 24, 2018

For small, private companies, I'm not sure there really is an easy one-size-fits-all quantitative way to evaluate tenants. We just put in a restaurant tenant who developed a new concept at our location. It cost us $500,000 in TI/LC to build out a spot for a start-up business. But this business is run by a small restaurant group that is so far 3/3 in creating successful restaurant concepts in the same neighborhood. Of course, there was 2-3 months rent deposit and a "guaranty" made by the company's LLC. But really--how do you quantitatively model that? Another one we're doing now is a Domino's--the group owns 30 successful Domino's franchise locations, so we pretty much assume they know what they're doing. We've spent basically zero time diving into their financials.

I've done leases now for maybe 70 small office and retail tenants. I've found that analysis relies heavily on intuition and commonsense. Do they have decent liquidity? Is their rent at this new location substantially higher than before? If so, what new revenue sources are they expecting to pay for this increased cost? Does their business cash flow? If not, is that because the owner is paying himself a big salary (if so, that's ok, because that really means the business is profitable)?

Since I've been here, ironically, the only deal that's blown up has been the major office tenant we signed (half a building) that we did a financial and business deep dive into thanks to them being publicly traded. Well, 4 years later, they're bankrupt. In my defense, they were signed right before I was hired. :)

Aug 24, 2018