How to Evaluate a Commercial Property Tenant Before You Buy

The first step is obvious, but important.

Who is actually renting the property?

Is it an established company? A newly incorporated business? A sole proprietor? A company operating multiple outlets?

The company name alone doesn't tell you whether the tenancy is strong.

I want to understand the tenant's business and how dependent that business is on the particular premises.

For example, a well-established operator with multiple outlets may have a different risk profile from a newly established business that is heavily dependent on one location.

The objective isn't to judge the tenant.

It is to understand the strength and sustainability of the rental income you are buying.

The tenant's business model matters.

A property occupied by a business that has a strong and sustainable demand may have a different leasing outlook from one occupied by a business operating in a highly competitive or changing sector.

I would consider:

• What industry is the tenant in?
• What type of customers do they serve?
• Does the business require this particular location?
• Is the property important to their operations?
• Would relocating be easy for them?
• Are there reasons for the tenant to remain long term?

This gives you a better understanding of why the tenant is paying the rent, rather than simply knowing how much rent they are paying.

A tenant with five years remaining on the lease gives you a different level of income visibility from one whose lease expires in six months.

Before buying, check:

• Lease commencement date
• Lease expiry date
• Rental amount
• Rental escalation, if any
• Renewal options
• Security deposit
• Other important tenancy terms

A longer lease can provide greater income visibility, but it is still important to consider whether the current rental is sustainable.

A long lease at an unrealistic rental does not necessarily eliminate your risk.

This is one of the most important questions I would ask.

Suppose a property is generating $15,000 a month and the seller tells you that the property produces a 5% gross yield.

That sounds attractive.

But what if comparable properties are actually renting for $11,000?

The current rental may be benefiting from an unusually strong tenancy arrangement that may not be repeated when the lease expires.

I therefore want to compare the current rent against prevailing market rental levels and the property's actual characteristics.

The objective is not simply to find the highest rental.

It is to understand whether the income you are buying is realistic and sustainable.

This is the question many investors don't ask because they are focused on the existing rental.

But every tenancy eventually faces renewal or expiry.

So I ask:

If this tenant leaves tomorrow, who is going to rent the property?

Look at the property's:

• Location
• Size
• Layout
• Accessibility
• Visibility
• Approved use
• Rental level
• Target tenant pool

A property with a broad range of potential tenants may be easier to re-let than one designed for a very specific business.

This is why I don't evaluate the current tenant in isolation.

I also consider the replacement tenant market.

Some businesses become closely associated with a particular location.

That can be positive.

A successful restaurant, established retail operator or long-term office tenant may have strong reasons to remain.

But there can also be risk if the property's investment case depends almost entirely on one tenant continuing indefinitely.

Ask yourself:

If the tenant leaves, does the property still make sense?

If the answer is yes because there is strong underlying demand for the property, that gives you another layer of comfort.

If the answer is no, then the tenant may be carrying much more of the investment risk than you initially realised.

This is ultimately how I would approach a tenanted commercial property.

Don't look at Property and Tenant as two completely separate things.

Look at them together.

A strong tenant in a weak property may not be enough.

A great property with an unsustainable rental may also create problems.

But when you have:

A suitable property + sustainable rental + suitable tenant + reasonable lease terms + strong replacement demand

you have a much clearer investment story.

That is the combination I want to understand before recommending a property.