Office Landlords Beef Up
Credit Checks of Tenants

Once bitten, twice a spy.

Burned by tenants who negotiated costly structural improvements into their lease deals only to later default or break those leases, office landlords have been doing double duty as detectives. These days, they're more aggressively checking prospective tenants' credit histories, financial statements and whether they've paid everything from the phone company to Federal Express on time.

At least three big office landlords, Arden Realty Inc., Transwestern Investment Co. and Trizec Properties Inc., have hired Chicago-based real-estate services firm Property Assessment Advisors Inc. to comb through documents, records and receipts of prospective and even existing tenants, and interrogate firms that have done business with the tenant.

"Clearly, as the real-estate fundamentals have softened, tenants are commanding higher concession packages, which means our capital commitment is higher, so understanding a tenant's credit is very important," says Randy Bessolo, managing director at Transwestern, a Chicago-based, real-estate investment firm that owns 63 office properties throughout the country. Transwestern signed up to use Property Assessment Advisors' tenant-risk assessment service last month.

Given that there's less demand for space, adds Mr. Bessolo, "we will take a little more risk with some tenants that we might have dismissed as uncreditworthy in the past. This service helps us in terms of making those judgments."

A Needed Filter

To be sure, landlords are still offering generous incentives to attract tenants. And tenants that aren't making big demands for structural improvements can literally move right in without being as ruthlessly screened. But tenants looking for a landlord to spend lots of bucks upgrading and retrofitting the space before committing better brace for the scrutiny.

The new attitude comes as the nation's office market is in its worst slump in a decade. The national office-vacancy rate is at 16%, its highest level since 1993, according to Reis Inc., a New York real-estate research firm. Meanwhile, average rents for office buildings are down 1.3%.

Equity Office Properties Trust, the nation's largest office landlord, beefed up its credit group, which is responsible for looking at the credit of prospective tenants, doubling its staff to 10. The Chicago-based real-estate investment trust also licensed a software program designed by Moody's KMV, a unit of New York-based Moody's Corp., that assigns credit ratings to prospective tenants. The company took both actions last summer as the economy continued weakening.

"As you look out there in corporate America, you have to be concerned about the creditworthiness of all your prospective tenants," says Marsha C. Williams, Equity Office's chief financial officer. "We believe that this will help us make better and more timely decisions."

Even smaller deals that used to receive barely a glance are being more closely scrutinized. Highwoods Properties Inc. has lowered the size threshold for prospective tenants on which its credit committee conducts reviews. The size of the prospective tenant subject to review is "smaller than it was two years ago," says Carman J. Liuzzo., the chief financial officer of the Raleigh, N.C.-based office REIT. "We just think it's prudent to broaden the scope of the reviews, given the economic environment." US Airways Group Inc. and WorldCom Inc. rejected most of their leases with Highwoods after they each filed for bankruptcy-law protection.

The added scrutiny isn't coming cheap to landlords. Property Assessment Advisors offers its tenant risk-assessment product to customers for $595 per report. The reports, typically five to seven pages, include a financial statement review and analysis, a summary and analysis of credit reports, reference checks, a credit-risk model, a list of red flags -- typed in red -- uncovered during the investigation, and options on how the landlord should act based upon the information gathered.

Stan Schiller, executive vice president of Property Assessment Advisors, says business has "more than doubled" between 1997 and 2002, with most growth occurring in 2001 and 2002. He predicts business will nearly triple this year. Mr. Schiller recently expanded his five-member consulting staff to seven.

'A Little More Help'

Howard Stern, first vice president of leasing and operations at Arden Realty, says the Los Angeles office REIT has seen a 65% reduction in its account receivables over the past two years in part by utilizing tenant risk-assessments provided by Property Assessment Advisors. (Accounts receivable refers to money owed to a business for goods or services.) "Prior to this, we would have a larger number of tenants paying late," he says.

Landlords typically have some in-house system that often includes a Dun & Bradstreet report. But some analysts say they can understand why landlords would enlist outside assistance in assessing tenants. "Credit issues are more important than they were and the idea that you might want a little more help analyzing that is not surprising," says John Lutzius, an analyst at Green Street Advisors Inc., a Newport Beach, Calif., research firm.

Brokers, however, aren't convinced landlords should have to pay firms to do what they already do as part of their job representing landlords. "For the most part, the fundamental background information is readily available," says Arthur Bocchi, a senior managing director at Cushman & Wakefield Inc., a New York-based real-estate services firm.

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