What due diligence ensures tenant creditworthiness for sale to institutional buyers?

When industrial property is intended for sale to institutional buyers (such as REITs, funds, or core asset investors), the creditworthiness of the tenant becomes a central valuation factor. Institutional buyers prioritize stable, long-term cash flows backed by financially sound tenants. As such, sellers must perform thorough due diligence to confirm and document the tenant’s financial health, legal compliance, and operational stability.

Below are the essential areas of tenant creditworthiness due diligence:

1. Financial Strength Assessment

• Documents to Review:
  
  • Audited financial statements (last 3 years)
    
  • Bank statements or credit line facilities
    
  • Credit rating reports (CRISIL, ICRA, CARE, etc.)
    
• Key Indicators:
  
  • Profitability and liquidity ratios
    
  • Net worth and debt-to-equity ratio
    
  • Ability to cover lease obligations (DSCR, EBITDAR)
    
• Institutional Requirement: Buyers often demand tenants with a BBB rating or above, or a demonstrable track record of financial stability.

2. Business Tenure and Market Reputation

• Due Diligence Actions:
  
  • Verify incorporation date and promoter background.
    
  • Review media coverage, client base, and certifications (ISO, GMP, etc.)
    
  • Cross-check for litigation history or regulatory violations.
    
• Why It Matters:
  
  • Longevity and brand strength reduce the risk of mid-term vacancy.
    
  • Reputable firms attract better buyer valuations and lower cap rate discounts.

3. Lease Agreement Review

• Terms to Ensure:
  
  • Minimum 5–9 years lease term with 3–5 years lock-in.
    
  • Escalation clause (5–7% annually or every 3 years).
    
  • Clearly stated termination, default, and dispute resolution clauses.
    
• Institutional Focus:
  
  • Clarity of cash flows, enforcement strength, and post-termination recovery terms.
    
  • Buyers want assignable or transferable leases in the event of asset sale.

4. Operational Dependency on Location

• Due Diligence Checks:
  
  • Is the tenant’s business site-specific (e.g., near a port, cluster, highway)?
    
  • Is the site tied to licenses, plant registrations, or vendor contracts?
    
• Investor Insight:
  
  • Tenants who invest heavily in fit-outs, licenses, or logistics near the site are less likely to relocate, adding security to future rental income.

5. Rent-to-Revenue and Occupancy Cost Analysis

• Benchmarks:
  
  • Industrial rent-to-revenue ratio should ideally be under 5–8%.
    
  • Higher ratios may indicate strain or future lease renegotiation risk.
    
• Institutional Preference:
  

Prefer tenants with low occupancy costs relative to their core business turnover.