Net Lease 101: Credit Grade Tenants

Tim Milazzo
July 18, 2022

One of the easiest pieces of underwriting in the commercial real estate industry is when a credit grade tenant signs a long-term net-lease agreement. If Starbucks promises to rent your property for the next 15 years, you can literally take that to the bank.

That’s because Starbucks is a “Credit Grade” tenant, also simply referred to as a “Credit Tenant”. I’ll use the two terms interchangeably here.

What is “Credit Grade”?

When you hear this term, someone is describing the financial strength of a property’s tenant. Credit Grade is not a commercial real estate professional’s opinion of a tenant’s finances. However, it is derived from the technical term “Investment Grade”, which is used to describe the corporate bonds issued by a company, and an independent rating agency has rated those bonds at one of the tiers indicative of high-quality borrowers.

The three dominant independent rating agencies in the US are Moody’s, Standard & Poors (“S&P”), and Fitch. You can determine if a tenant is “Credit Grade” based on their bond ratings falling within the “Investment Grade” bucket below:

How Credit Grade Impacts Commercial Real Estate

In general, attracting financially stable tenants helps to make a property’s income more certain. The added benefit of the official “Credit Tenant” status would be that other players in the capital markets (buyers and lenders) can immediately recognize and validate the tenant’s healthy financial status. That leads to a higher property value and less financing risk.

Some property owners are willing to negotiate a lower rent rate in a lease agreement with a credit grade tenant just to ensure they have the added benefits above. This is especially true of Single Tenant Net Lease (“STNL”) properties, which are commonly leased to these credit tenants. For multi-tenant properties, a credit tenant may act as the anchor tenant for the property, virtually guaranteeing a level of income and allowing other, more risky tenants to pay more rent in other units.

How a Credit Tenant’s Financials Affect Property Financing Options

In the absence of a Credit Tenant, financing sources must underwrite the tenant’s financials directly, rather than relying on an independent rating agency’s official opinion. This creates more work for the financing source, which will already limit the available pool of capital sources.

Of course, the results of that financial underwriting of the tenant may reveal a risk that they could default on their lease agreement. That added risk further limits the pool of capital sources, and also makes financing more expensive through a combination of higher interest rates, lower leverage, or higher capital reserve requirements.

Having a credit tenant guaranteeing a lease agreement is one of those “take it to the bank” moments in commercial real estate. You’ll be able to secure attractive permanent financing, or a very high leverage construction loan.

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