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What Should You Do When A Commercial Tenant Defaults On A Lease?

Buying a commercial income property offers its own set of rewards, but also carries its own set of risks too.

One risk that can hit a commercial real estate owner hard occurs when the commercial tenant still under lease, decides to break the lease, usually for financial reasons. Unfortunately, the time to worry about how to fix the situation is not when a tenant wants to end the lease prematurely, but before a tenant signs the lease.

commercial tenant

 

NEGOTIATING A FAIR LEASE AFFECTS THE PROPERTY’S RESALE PRICE

It may be obvious that a well-written lease benefits you in the short-term, by setting the rules for the tenant-landlord relationship. However, a well-written lease also affects your property’s resale price in the long-term.

That’s because the closer a lease is to ending, the less time a buyer has until they’ll have to find a new commercial tenant. Finding a new commercial tenant is not only difficult, but costly as well. It makes sense that a property that is fully let – and that will be rented out for the next 20 years – will be worth more than one whose leases are about to come due.

 

CO-TENANT ANCHOR CLAUSES ARE THE EXCEPTION

Depending on the state, a commercial tenant who defaults may choose to “buy out” the landlord by offering a sum of money to break the lease, while others may have the option of sub-letting the space. In co-tenant anchor leases, however, tenants have rights based on the anchor store.

For example, in the case of a small shopping center which consists of several smaller stores and an anchor store like Costco, the tenants in the smaller stores pay more per square foot than the anchor store. That’s because it is presumed that the anchor store is providing large amounts of traffic which benefit the smaller stores.

If the anchor store then goes out of business, then the smaller stores are no longer benefiting from the traffic it brought in: they can then legally break the lease and move elsewhere, or ask for a reduction in rent until a new anchor store is signed up.

 

LATE PAYMENTS MAY HINT TOWARDS DEFAULT

Prevention is better than a cure.

If you notice that a tenant begins paying rent late when they had previously paid on time, that’s a hint that sales are down, and they are in financial trouble.

In such a case, it might be advisable to approach the tenant first, rather than being hit with a surprise default. Although you would still have to pay for repairs and rehabs when the tenant moves out, it would make it possible for you to avoid unrented space by finding a replacement tenant before they leave.

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Tags: commercial income property, commercial real estate owner, commercial tenant