The Myth of The National Credit Tenant
October 2005 – By Jack Garson. Print Article
The most popular American myths include Bigfoot, Elvis sightings, Area 51 and the Roswell Incident. Now, add another myth to the list the myth of the national credit tenant (NCT). According to this myth, an NCT is always the best tenant for your retail properties; NCTs attract other tenants who pay high rents, and landlords who lease to an NCT will enjoy a stable, secure stream of rent, a better bottom line and a more valuable property. To be sure, NCTs provide considerable benefits. NCTs can attract shoppers and other tenants. There is certain reliability with an NCT as a proven business model. NCTs can impress lenders and purchasers as long as they do not read the fine print of leases! Similarly, for the publicly traded landlord, Wall Street clearly favors a portfolio of properties filled with NCTs.
Separating Fact From Fiction
The fiction is that an NCT is always the best possible tenant. The fiction is that NCTs should fill the majority, if not all, of the spaces in your retail properties. The fact, however, is that some landlords may benefit from using NCTs sparingly, as anchors and niche players. The fact is that the costs of leasing to some NCTs exceed their value. Take, for example, the belief that NCTs are reliable retailers that attract other higher rent-paying tenants. As any experienced landlord, tenant or broker knows, landlords want retail tenants that will continuously conduct business in their premises, abiding by the landlords schedule for minimum hours and days of operation. Depending on the retail property, a landlord might require continuous operations for nine or more hours per day, six to seven days per week, throughout the year, with store closings only on certain holidays, for periodic renovations, or for unusual weather or other force majeure causes beyond the control of the tenant. The fact is that many NCTs will not even agree ever to open their doors and do business at your property. A typical such non-operation clause reads as follows: Nothing in this lease or otherwise shall require tenant to keep the demised premises open for business at any time.
Still other NCTs grudgingly agree to open their stores for one day only and thereafter are forever relieved of any obligation to conduct business at your property. The following is an actual and typical open for one day provision: Within 90 days following the rent commencement date, tenant agrees to fixture the leased premises, stock merchandise therein and open the same as a grocery supermarket of the same general character as the majority of tenants other new stores. Notwithstanding a tenants agreement to open, the landlord agrees that the tenant, its subtenants or assignees shall not be obligated to operate any particular type of business in the leased premises and shall have the right to discontinue whatever type of business (grocery or otherwise) may exist from time to time in the leased premises. The tenant has the right in its sole discretion to decide whether or not to operate in the leased premises and in what manner to conduct operations, if any.
Landlords do usually bargain for and obtain the right to terminate (recapture) the NCT lease when the NCT stops operating for a protracted time period. In the meantime, however, an empty store hardly attracts customers and other tenants. Further, when a landlord recaptures an NCTs premises on account of such non-operation, the landlord usually has made and lost a considerable investment in rent abatement, tenant improvements and leasing commissions.
When NCTs do conduct business, they often prevent landlords from leasing to other tenants the very tenants that should pay the landlord higher rents and thereby justify, in part, the cost of doing business with the NCTs.
800-Pound Gorilla Grocery
Consider the modern day grocery store that is not satisfied with just selling groceries. This NCT requires the right to be a greeting card store, a beer and wine store, a florist, a drycleaner, a photo development shop and pharmacy and, more recently, a gas station and coffee cafe. Where is the benefit in building out and leasing 100,000 square feet at below market rents to a grocery store in the hope of attracting higher rent paying tenants for the smaller shops when this NCT reduces both your ability to attract these smaller tenants and the smaller tenants ability to pay those higher rents?
Consider also the assumption that an NCT generates a secure, stable stream of rent. Some NCTs tempt you with the credit of the parent company and then insist that you sign the lease with some asset-starved shell entity. In the lease itself, many NCTs require the right of setoff against the rent for countless potential landlord infractions, thereby undermining the security of the rental stream. Moreover, some NCTs with hundreds, or thousands, of stores actually have a lower net worth per store than a strong local or regional player competing for the same location.
Beware the Bankruptcy
Will your NCT be the one that adds 50 stores this year and then sheds 100 stores in bankruptcy next year? Does your NCT become the next Kmart (bankruptcy in 2002), Ames Department Stores (bankruptcy in 2001 and, before that, 1990), Montgomery Ward (bankruptcy in 1997), R.H. Macy & Co. (bankruptcy in 1992), Carter Hawley Hale Stores (bankruptcy in 1991), Federated Department Stores (bankruptcy in 1990), Circle K Stores (bankruptcy in 1990), Southland Corp (bankruptcy in 1990) or Revco Drug Stores (bankruptcy in 1988)? Note, also, that when an NCT files for bankruptcy, its leases may be sold to a new tenant that will be entitled to all the special rights you gave to your NCT. However, the new tenant may provide little, if any, of the special benefits of an NCT. Moreover, while you would expect to procure a long-term tenancy from an NCT, some often commit to lease terms of only 5 or 10 years. Nevertheless, the typical NCT insists on multiple options to renew the lease, which, as we all know, is a one-sided right to continue to enjoy the benefits of the lease without any obligations to extend the lease. Indeed, some NCTs commit to terms of only 5 or 10 years, but demand the right to options spanning 20 to 30 additional years some or all of which options are at pre-determined, below-market rents. Even more aggressive NCTs seek a right of first refusal or an outright option to lease expansion space at below-market rents.
Now add the unfortunate fact that the typical NCT wants considerable control not just over its premises, but also over your entire property. NCTs often insist that parking fields cannot be modified without their consent. Certain street entrances and exits must never be changed. Kiosks, buildings and other structures cannot be constructed in common areas or are limited by no build areas. Certain uses are prohibited altogether; other uses are restricted to certain locations and sizes, and the viability of many uses is reduced by the virtually unlimited uses reserved to many NCTs.
Additional ironies shatter the myth of the NCT:
- NCTs are touted as providing prestigious tenancies, yet NCTs usually insist on the right to assign and sublet to mom and pop operations.
- You bargain for an NCT with an established brand, but in the fine print of the lease, NCTs generally refuse to be required to operate under that brand name or retain liberal rights to use other names.
- NCTs are prized for their deep pockets, but NCTs insist that landlords pay for and construct a considerable portion of the tenants necessary improvements to their store.
Still, NCTs are often necessary. They can and do provide considerable benefits, such as drawing in shoppers and keeping parking lots full, providing extensive advertising, and offering innovative products and services. Many do have great credit and pristine balance sheets, justifiably impressing lenders, purchasers and Wall Street. Indeed, one prominent NCT alone can provide crucial credibility to a fledgling landlord or project. Overall, the best strategy is to obtain the best possible deal from NCTs. When you cant, then enter into leases with well qualified local and regional tenants. First, before you negotiate with an NCT over reductions in your proposed rent or other modifications to your pro forma lease terms,obtain and review the financial statements of the entity that will ultimately sign the lease as the tenant. Countless landlords have ignored this requirement and fallen prey to a bait and switch. The NCT dangles the bait of a national trade name, but switches to an entity with few or no assets to sign the lease as the tenant. Instead, review the balance sheet and operating statements of the entity that will actually sign the lease as the tenant. Where justified by the tenant, let the shell entity sign the lease as the tenant, but obtain the guaranty of the NCT.
Second, confront and resolve the difficult lease terms in advance, and include the negotiated terms in your letter of intent. Pay particular attention to any terms that reduce or impair the rental stream, such as exclusions from your standard common area expense pass-throughs, tenant setoff rights and extraordinary landlord maintenance obligations that are not reimbursed by the NCT. Also address use and operational requirements, such as exclusive use rights continuous operations, tenant rights to assign and sublet, required tenant trade names and uses, limits on other tenant uses, and other tenant controls over your property. Third and most important, find a number of potential candidates for your premises, and create an auction that awards the lease to the best overall tenant. Local and regional players with strong brands, business models and balance sheets, and reasonable expectations may be your best choice. Often, strong regional players that are just beginning their national expansion are excellent alternatives to established NCTs. Similarly, in smaller spaces, a local retailer with an established following can provide much of the allure and traffic of a comparable NCT usually with less onerous lease requirements.
Do Not Commit Too Early
The strategy of pursuing multiple tenants for one space requires tremendous discipline, but can also produce corresponding benefits. Unfortunately, in the typical scenario, the landlord solicits a prominent NCT. Once the NCT indicates an interest in leasing the premises, the focus of the landlord and its brokers all too often falls solely upon this one prospective tenant. Savvy NCTs know this and take advantage of it. Pressure builds within the landlords organization to consummate a lease with the NCT. Perhaps the landlord has scheduled a grand opening or negotiated construction loan terms or other leases that require the NCT. In any event, many landlords put themselves in a position of requiring a particular NCT and thereby reduce their negotiating power. As the deal progresses from letter of intent to lease document, the NCT may request additional concessions or reveal undesirable characteristics, such as less than stellar finances. The landlord may feel both that it is too late to start negotiations with another tenant and that the loss of time in pursuing a new deal is worse than making concessions to the NCT.
Alternatives Equal Bargaining Power
Instead, landlords should pursue the following strategy: Until a detailed and comprehensive letter of intent is executed by both landlord and NCT, and the form if not the content of the lease is agreed upon, the landlord should pursue alternate deals with other prospective tenants. Despite the cost of duplicate efforts, the benefits can be tremendous. Simply put, in commercial leasing, when you have alternatives, you have bargaining power. Understand that this pursuit of multiple transactions is not unfair to the tenant (although it may be fair to provide extra compensation to your brokers who pursue multiple deals to a more advanced stage). On the contrary, many NCTs pursue multiple locations until one deal has progressed to an advanced stage. Indeed, as we all know, the typical NCT is not reluctant to remind a landlord that the NCT can get a better deal down the street. An NCT lease is not always the best deal. Nevertheless, with the right leasing strategy, you can make better deals with NCTs and enter into leases with the best tenants for your property.