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7 questions retail landlords should ask if a tenant closes

Categories: Commercial

While a saviour for shoppers, online retail is a wolf for traditional store owners; huffing, puffing and blowing bricks and mortar stores down.

While not every retail landlord will see it happen, tenants do go bust. And the rise of e-commerce isn’t the only cause – negative consumer sentiment, poor business management, or customers being more cautious of their spending, might force a retailer to cease trading.

So, if a retail property landlord gets notice of their tenant closing its doors, what should be done? Here are the first 7 questions to answer if your retail tenant closes.

1. When will their business close?

It’s important to establish the date your tenant will exit the building so you understand:

  • The time until your investment’s cash flow is affected
  • When you can take possession of the premises

Also do some simple arithmetic for any outstanding rent payments. If the tenant has overdue rent you’ll want to reconcile it before they leave.

If it’s a national retailer going bust, the news might tell you when their business is closing. Publications waste no time announcing large, ASX-listed companies going into administration or closing stores. For some landlords, this might be the first notice that they’re about to lose a tenant.

2. How much time remains on the lease?

Three months? Or three years?

When a tenant exits your property before the lease is up, you become an unsecured creditor. That’s like a bank handing out a mortgage without taking property as collateral.

Your tenant has a commitment to pay rent and operate the premises for the entire period on the lease agreement. They are bound to their lease term. The more time left on the lease after your tenant closes, the more significant the loss of income.

A lengthy remaining lease term may also affect the property value. After all, the valuation is hugely dependent on the rental income and lease expiry of each tenant.

3. Why is the tenant closing?

In commercial property investment, the next best thing to a crystal ball is market information. The more you know, the better you can avoid your next tenant closing its doors:

Are changes in their industry or locale to blame?

Understanding what put the kiss of death on your tenant’s business will help you recognise whether your next tenant could have the same fate. Improved technology, disruptions by local redevelopments, and yes, the digital environment, are some examples.

Or maybe a fierce competitor is the culprit…

Bunnings arrived on Australia’s hardware store scene in the 1990s. Since then, it’s become the largest hardware chain in the country and has hammered local competitors. With thousands more independent stores set to close by 2024, a smart landlord wouldn’t add to the death toll by putting a small hardware store on their tenancy schedule.

Is it management’s fault?

In 2015, global retailer Stienhoff International had their operation fractured by internal accounting irregularities. The wrongdoings of the business resulted in several subsidiaries sinking earlier this year and the crisis continues to worsen. The group kept this information hidden from the public, deepening the haemorrhage for many of its businesses (and their landlords).

Before blaming the market, or the online wolf, investigate whether poor management like this is the reason your tenant has fallen over.

4. How will you recover lost rent?

Put your microscope over the long list of clauses and definitions in the lease agreement; you want to find what security is provided over the tenant’s obligations.

Is there a Bank Guarantee securing the lease?

A Bank Guarantee is a promise by a bank on behalf of the tenant to pay the landlord a specific amount. If one is securing the lease, you can be assured you’ll receive some compensation. This will give you breathing space.

Is a Guarantor involved in the agreement?

A Guarantor may be responsible for the rent if the tenant themselves are unable to compensate you. When the Guarantor signs the lease, they make a promise to you: ‘If anything happens to the tenant, we’ll step in and cover the lost rent.’

At the end of the day, your legal representative will be the one to confirm the next steps here. But understanding the tenant’s legal obligations is extremely important when establishing the financial impact of their departure.

5. Who is the actual owner of the business?

You might be thrilled your property is occupied by a major national or multinational business – and rightly so, they generally make great tenants – unless their operation is in the 1.3 per cent of consumer goods retailers in Australia forecasted to close throughout the year.

If a major retailer is suddenly exiting your property, check who legally owns the business.

It could be owned by a subsidiary company operating separately from their parent (i.e. a local Pty Ltd). This may mean you will struggle with compensation for lost rent; the business owner may have nothing for you to go after.

But all may not be lost, as the parent company is often Guarantor for the smaller subsidiary, and will take responsibility of the closure. The parent may still be breathing while their subsidiaries are forced to close. But first, size up the Guarantor’s financial strength and make sure they’re able to cover the tenant’s obligations.

The myriad of different corporate structures can make things complicated for landlords. So when in doubt of your understanding, seek advice from your accountant and solicitor.

6. Can you still service your debt?

Commercial property loans come with loan covenants – certain conditions which the borrower must adhere to throughout the term of the loan agreement.

One common covenant is the Interest Coverage Ratio (ICR), which the bank uses to understand how easily a borrower’s income will cover interest repayments.

Losing your tenant’s income could impact your ICR. And if there’s a significant change to this loan covenant, you might have an issue with the bank.

One way to compensate for a battered Interest Cover is by securing your lease with a Bank Guarantee – a promise by the bank on behalf of the tenant to pay the landlord (much like holding a tenant’s bond). It might give you several months of rental income, meaning you have some breathing space to continue repaying your loan. Meanwhile you can focus on understanding what happened to your tenant and reposition the property in the market.

7. When will the default notice be issued to the tenant?

Sure, you know the tenant is closing. Maybe they’ve notified you in writing or you’ve seen it in news headlines. Even the very act of going into receivership or voluntary administration is a default of most lease agreements.

But until you issue them with a formal default notice they haven’t legally broken any conditions in the lease.

The Default Provisions in the lease explain what the tenant must do if they break any conditions. For example, if your tenant misses several rent payments, they might need to hand over their Bank Guarantee. But for you to protect your rights under the lease and get your lost rent back, they need to receive formal written notice.

Again, consult your solicitor when preparing these formalities. Your rights as landlord can be seriously affected if not done correctly.

Now… find a replacement.

Many would imagine this is step one. But while you can always look for a new tenant in the background, you must assess the problem before finding a solution. Once you’ve found the wolf that drew blood from your tenant’s business, it’s time to look for a replacement.

The sudden loss of a tenant is one of the challenges in commercial property investment. Many will avoid the pain by investing in a property syndicate. To find out how to get involved in one of our commercial property investments, get in touch with Properties & Pathways.