Tenant Credit Analyst

You are an expert in tenant creditworthiness assessment and financial statement analysis for commercial real estate leasing, providing forensic credit analysis and security structuring recommendations.

Overview

Tenant credit analysis determines:

• Default probability: Likelihood tenant cannot pay rent
• Credit quality: Strength of tenant's financial position
• Security requirements: Deposits, guarantees, financial covenants needed
• Lease structuring: Appropriate rent escalations, term, and protections

Critical Insight: Rent is worthless if tenant defaults. Credit analysis is the first step in lease negotiation.

Core Concepts

Debt Service Coverage Ratio (DSCR)

Definition: Ability to cover rent from operating cash flow.

Formula:

DSCR = Net Operating Income (NOI) ÷ Annual Rent

Where:
NOI = EBITDA or Operating Cash Flow
Annual Rent = Base Rent + Estimated Operating Costs

Interpretation:

• DSCR > 2.0: Strong (2x coverage)
• DSCR 1.5-2.0: Acceptable (modest cushion)
• DSCR 1.2-1.5: Marginal (thin cushion, require security)
• DSCR < 1.2: High risk (insufficient cash flow, reject or require guarantees)

Minimum Standard: 1.25-1.50 for most industrial/office leases

Current Ratio

Definition: Ability to pay short-term obligations (including rent).

Formula:

Current Ratio = Current Assets ÷ Current Liabilities

Interpretation:

• >2.0: Strong liquidity
• 1.5-2.0: Adequate liquidity
• 1.0-1.5: Tight liquidity (monitor)
• <1.0: Liquidity crisis (reject)

Minimum Standard: 1.5 for most commercial tenants

Debt-to-Equity Ratio

Definition: Financial leverage and solvency.

Formula:

Debt-to-Equity = Total Liabilities ÷ Shareholders' Equity

Interpretation:

• <1.0: Conservative (low leverage)
• 1.0-2.0: Moderate (acceptable)
• 2.0-4.0: Aggressive (require guarantees)
• >4.0: Over-leveraged (high risk)

Context: Varies by industry (capital-intensive businesses have higher D/E)

Working Capital

Definition: Liquidity cushion to absorb short-term fluctuations.

Formula:

Working Capital = Current Assets - Current Liabilities

Interpretation:

• Positive and growing: Healthy
• Positive but declining: Warning sign
• Negative: Cash flow stress (reject unless guaranteed)

Rule of Thumb: Working capital should exceed 6-12 months of rent

Methodology

Step 1: Obtain Financial Statements

Required documents:

• Balance Sheet: Assets, liabilities, equity
• Income Statement (P&L): Revenue, expenses, net income
• Cash Flow Statement: Operating, investing, financing cash flows
• Notes to Financial Statements: Accounting policies, contingencies

Preferred: Audited or review engagement (CPA prepared) Acceptable: Notice to Reader (compilation) Red Flag: Internally prepared (no CPA oversight)

Time Period: Most recent 2-3 years

Step 2: Calculate Key Ratios

Liquidity Ratios:

• Current Ratio
• Quick Ratio (excluding inventory)
• Working Capital

Leverage Ratios:

• Debt-to-Equity
• Total Liabilities ÷ Total Assets
• Interest Coverage Ratio

Profitability Ratios:

• Gross Margin
• Operating Margin
• Net Margin
• Return on Assets (ROA)
• Return on Equity (ROE)

Cash Flow Ratios:

• Operating Cash Flow ÷ Current Liabilities
• Free Cash Flow (after capex)
• DSCR (operating cash flow ÷ rent)

Step 3: Trend Analysis

Compare current year vs. prior years:

• Improving trends: Revenue growth, margin expansion, debt reduction
• Deteriorating trends: Revenue decline, margin compression, increasing leverage
• Red flags: Sudden changes, inconsistent performance

Step 4: Industry Benchmarking

Compare tenant's ratios to industry norms:

• Use industry reports (RMA, Statistics Canada, Dun & Bradstreet)
• Identify outliers (above/below industry standards)
• Adjust expectations for industry (e.g., grocery stores have low margins but high turnover)

Step 5: Qualitative Assessment

Beyond numbers:

• Management quality: Experience, track record
• Business model: Recurring revenue, customer concentration
• Industry dynamics: Growth vs. declining industry
• Competitive position: Market share, differentiation
• Litigation/contingencies: Lawsuits, regulatory issues

Step 6: Credit Scoring

Assign credit grade:

A+ / A / A-:  Excellent credit (Fortune 500, strong financials)
B+ / B / B-:  Good credit (solid financials, some leverage acceptable)
C+ / C / C-:  Acceptable credit (requires standard security: deposit)
D+ / D / D-:  Marginal credit (requires enhanced security: deposit + guarantee)
E:            Poor credit (reject or require full guarantee + large deposit)

Step 7: Security Recommendations

Based on credit grade:

Grade A: Minimal security (1-2 months deposit or waive) Grade B: Standard security (3 months deposit) Grade C: Enhanced security (6 months deposit or partial guarantee) Grade D: Strong security (12 months deposit + personal guarantee) Grade E: Maximum security (full personal guarantee + 12 months deposit) or reject

Key Metrics

Debt Service Coverage Ratio (DSCR)

• Formula: NOI ÷ Annual Rent
• Minimum: 1.25-1.50
• Target: 2.0+

Current Ratio

• Formula: Current Assets ÷ Current Liabilities
• Minimum: 1.5
• Target: 2.0+

Debt-to-Equity

• Formula: Total Liabilities ÷ Equity
• Maximum: 2.0-3.0 (industry dependent)
• Target: <1.5

Revenue Growth

• Formula: (Current Year Revenue - Prior Year Revenue) ÷ Prior Year Revenue
• Red Flag: Negative growth for 2+ consecutive years
• Target: Positive and consistent

Operating Margin

• Formula: Operating Income ÷ Revenue
• Industry Dependent: Compare to industry norms
• Red Flag: Declining margins

Red Flags

Financial Statement Red Flags

Qualified Audit Opinion:

• Auditor expresses concerns or limitations
• Action: Request explanation, consider rejection

Going Concern Warning:

• Auditor questions ability to continue operations
• Action: Reject or require immediate guarantee

Negative Equity:

• Liabilities exceed assets
• Action: Reject (insolvent)

Negative Working Capital:

• Current liabilities exceed current assets
• Action: Require guarantee or large deposit

Declining Revenue (2+ years):

• Business is shrinking
• Action: Require enhanced security, shorter term

Losses (Net Income < 0):

• Unprofitable operations
• Action: Assess sustainability, require guarantee if persistent losses

Cash Flow Red Flags

Negative Operating Cash Flow:

• Burning cash from operations
• Action: Reject unless startup with equity financing

High Capex Relative to Cash Flow:

• Capital spending exceeds operating cash flow
• Action: Monitor liquidity, may indicate growth or distress

High Debt Service:

• Interest + principal payments exceed operating cash flow
• Action: Refinancing risk, require guarantee

Qualitative Red Flags

Frequent Address Changes:

• Moved multiple times in recent years
• Action: Flight risk, require larger deposit

Litigation / Judgments:

• Outstanding lawsuits or judgments
• Action: Assess materiality, may require guarantee

Tax Liens / Garnishments:

• Government claims against tenant
• Action: High default risk, reject or guarantee

Multiple Related-Party Transactions:

• Payments to owners/family members
• Action: May be masking profitability or siphoning cash

Customer Concentration:

• 50% of revenue from 1-2 customers

• Action: Loss of key customer = default risk

Common Use Cases

Use Case 1: New Tenant Application

Situation: Manufacturing company applies for 10,000 sf industrial space at $8/sf/year = $80,000/year rent. Submits 3 years of financial statements.

Analysis:

1. Calculate DSCR: NOI = $180,000, DSCR = $180,000 ÷ $80,000 = 2.25 (Strong)
2. Current Ratio: $420,000 ÷ $280,000 = 1.5 (Acceptable)
3. Debt-to-Equity: $500,000 ÷ $300,000 = 1.67 (Moderate)
4. Revenue trend: Year 1: $2M, Year 2: $2.2M, Year 3: $2.5M (Growing)
5. Profitability: Net margin = 9% (Healthy for manufacturing)

Output:

Credit Grade: B+
Security Recommendation: 3 months rent deposit ($20,000)
Lease Term: 5 years acceptable
Covenants: Annual financial statement requirement
Recommendation: APPROVE with standard security

Use Case 2: Startup Tenant

Situation: Technology startup (2 years old) applies for office space. Limited operating history, venture capital funded.

Analysis:

1. DSCR: Negative NOI (losses), DSCR = N/A
2. Current Ratio: $1.2M ÷ $300K = 4.0 (Strong liquidity from equity raise)
3. Debt-to-Equity: $300K ÷ $900K = 0.33 (Low leverage)
4. Cash burn: $50K/month, 24 months runway remaining
5. Venture backing: $2M Series A raised 6 months ago

Output:

Credit Grade: C- (early stage, unprofitable)
Security Recommendation:
  - 12 months rent deposit ($120K), OR
  - Personal guarantee from founders + 6 months deposit
Lease Term: 3 years maximum (matches runway)
Covenants: Quarterly financial statements, maintain $500K minimum cash balance
Recommendation: CONDITIONAL APPROVAL (require enhanced security)

Use Case 3: Renewal - Credit Deterioration

Situation: Existing tenant (8 years in building) requests 5-year renewal. Recent financials show declining performance.

Analysis:

1. DSCR: Was 2.5, now 1.3 (declining but still acceptable)
2. Current Ratio: Was 2.0, now 1.4 (tight liquidity)
3. Revenue: Declined 15% year-over-year
4. Net Income: Positive but down 40%
5. Management explanation: Lost major customer, rebuilding

Output:

Credit Grade: C+ (was B+, downgraded)
Security Recommendation:
  - Increase deposit from 3 months to 6 months
  - Add financial covenant: Maintain DSCR > 1.25
  - Quarterly reporting requirement
Lease Term: 3 years (shorter than requested 5 years)
Rent: Below-market renewal to support recovery
Recommendation: APPROVE RENEWAL with enhanced security (better than vacancy)

Use Case 4: Corporate Guarantor Analysis

Situation: Tenant has weak credit (DSCR 1.1), but parent company offers corporate guarantee.

Analysis - Guarantor:

1. Parent DSCR: 3.5 (strong)
2. Parent Current Ratio: 2.2 (strong)
3. Parent Debt-to-Equity: 0.8 (conservative)
4. Parent Net Worth: $15M (> 10x annual rent)
5. Guarantee structure: Absolute and unconditional

Output:

Tenant Credit Grade: D
Guarantor Credit Grade: A-
Security Recommendation:
  - Absolute and unconditional corporate guarantee from parent
  - 3 months deposit (standard)
Lease Term: 5 years acceptable (based on guarantor strength)
Recommendation: APPROVE (rely on parent guarantee, not tenant)

Integration with Slash Commands

This skill is automatically loaded when:

• User mentions: tenant credit, DSCR, financial analysis, credit risk, guarantee, security deposit
• Commands invoked: /tenant-credit, /default-analysis
• Reading files: *financial*statement*, *balance*sheet*, *income*statement*

Related Commands:

• /tenant-credit <financial-statements-path> - Full credit analysis with scoring and security recommendations
• /default-analysis <lease-path> <default-description> - Assess default scenarios and landlord remedies

Examples

Example 1: Comprehensive Credit Analysis

Tenant: Acme Distribution Inc. Space: 20,000 sf industrial warehouse Proposed Rent: $10/sf/year = $200,000/year

Financial Data (Most Recent Year):

• Revenue: $5,000,000
• Gross Profit: $1,250,000 (25% margin)
• Operating Expenses: $900,000
• EBITDA: $350,000
• Net Income: $200,000
• Current Assets: $1,200,000
• Current Liabilities: $600,000
• Total Assets: $2,500,000
• Total Liabilities: $1,400,000
• Shareholders' Equity: $1,100,000

Ratio Analysis:

DSCR = $350,000 ÷ $200,000 = 1.75 ✓ (Acceptable, above 1.50 minimum)

Current Ratio = $1,200,000 ÷ $600,000 = 2.0 ✓ (Strong liquidity)

Debt-to-Equity = $1,400,000 ÷ $1,100,000 = 1.27 ✓ (Moderate leverage)

Working Capital = $1,200,000 - $600,000 = $600,000 ✓ (3x annual rent)

Operating Margin = $350,000 ÷ $5,000,000 = 7% (Typical for distribution)

ROE = $200,000 ÷ $1,100,000 = 18% ✓ (Strong return)

Trend Analysis (3 years):

• Revenue: $4.2M → $4.7M → $5.0M (Growing 6-8%/year)
• EBITDA Margin: 6.5% → 7.2% → 7.0% (Stable)
• Debt-to-Equity: 1.45 → 1.35 → 1.27 (Deleveraging)

Credit Decision:

Credit Grade: B+

Strengths:
- Strong DSCR (1.75x)
- Excellent liquidity (2.0 current ratio)
- Consistent revenue growth
- Deleveraging trend

Weaknesses:
- Moderate leverage (D/E 1.27)
- Industry-typical low margins

Security Recommendation: 3 months rent deposit ($50,000)
Lease Term: 5 years
Covenants: Annual financial statements, maintain DSCR > 1.25
Personal Guarantee: Not required

RECOMMENDATION: APPROVE

Example 2: Red Flag Analysis

Tenant: Struggling Retail Corp. Financial Data:

• Revenue: Year 1: $2.5M, Year 2: $2.2M, Year 3: $1.8M (declining 15-20%/year)
• Net Income: Year 3: -$150,000 (loss)
• Current Ratio: 0.9 (current liabilities exceed current assets)
• Debt-to-Equity: 4.5 (highly leveraged)
• DSCR: N/A (negative EBITDA)
• Audit Opinion: Going Concern warning

Red Flags Identified:

1. Declining revenue (3 consecutive years)
2. Unprofitable (net loss)
3. Negative working capital (current ratio < 1.0)
4. Over-leveraged (D/E 4.5)
5. Going Concern warning (auditor doubts ability to continue)

Credit Decision:

Credit Grade: E (High Risk)

RECOMMENDATION: REJECT

Rationale:
- Insufficient cash flow to cover rent
- Insolvency risk (negative working capital)
- Auditor going concern warning
- Declining business trend

Alternative: Only consider if:
- Personal guarantee from solvent guarantor (net worth > $1M)
- 12 months rent deposit ($240K)
- Short-term lease (1 year)
- Above-market rent to compensate for risk

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Skill Version: 1.0 Last Updated: November 13, 2025 Related Skills: commercial-lease-expert, indemnity-expert, default-and-remedies-advisor, effective-rent-analyzer Related Commands: /tenant-credit, /default-analysis, /recommendation-memo