Tenant Due Diligence 101: What Landlords Must Know Before Signing a 10-Year Lease

In 35 years of leasing space in Worcester County, I've watched the deals that go sideways almost always trace back to the same thing: nobody did the homework on the tenant before signing. Tenant due diligence is the most important step before you commit to a long-term lease, because one default can cost a landlord hundreds of thousands in lost rent, legal fees, and carrying costs. CBRE puts numbers to it: landlords who run a real screening process (financial analysis, business viability, background checks) cut tenant default rates by over 60%.

The stakes are high

A 10-year lease on a 10,000 SF retail space at $25/SF is $2.5 million in contracted revenue. When a tenant defaults after year 3, you don't just lose the rent. You eat carrying costs while the space sits, you write off the tenant improvements you paid for, and you lose the time value of income that shows up years late, if at all.

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The best lease is worthless if the tenant can't pay. Every dollar spent on due diligence saves ten dollars in potential losses.

The four pillars of tenant due diligence

I break a tenant evaluation into four areas:

1. Financial Capacity - Can they afford the rent?
2. Business Viability - Will they succeed long-term?
3. Character Assessment - Are they reliable partners?
4. Structural Protections - How is the lease protected?

Here's how I work through each one.

Pillar 1: Financial capacity

Personal guarantee assessment

For small and mid-size tenants, I want a personal guarantee. No exceptions I can think of. Evaluate the guarantor on:

Net Worth Requirements:

• Minimum: 2x total lease obligation (rent × term)
• Preferred: 3x+ total lease obligation
• Liquid assets: At least 1 year of rent in accessible funds

Documentation Required:

• Personal Financial Statement (PFS) - dated within 90 days
• Two years of personal tax returns
• Bank and brokerage statements
• Schedule of real estate holdings
• Credit report authorization

Red Flags:

• Net worth concentrated in illiquid assets
• Significant contingent liabilities
• Recent asset transfers
• Multiple existing guarantees
• Declining net worth trend

Business financial analysis

Now look at the operating entity itself:

Key Ratios to Calculate:

1. Rent-to-Revenue Ratio: Monthly rent ÷ Monthly revenue
   • Retail: Should be <8%
   • Office/Professional: Should be <12%
   • Restaurant: Should be <10%
2. Current Ratio: Current assets ÷ Current liabilities
   • Should be >1.5, ideally >2.0
3. Debt Service Coverage: EBITDA ÷ Total debt service
   • Should be >1.25

Credit reports and history

Business Credit Reports (Dun & Bradstreet, Experian Business):

• PAYDEX score (80+ preferred)
• Payment history patterns
• Liens and judgments
• Years in business

Personal Credit Scores:

• 700+ for guarantors preferred
• 650-700 requires additional security
• Below 650: proceed with caution or additional collateral

Pillar 2: Business viability

Industry analysis

A tenant can look fine on paper and still be in a business that's dying. Understand where they sit in their industry:

Market Research:

• Industry growth trends
• Competitive landscape
• Technology disruption risks
• Regulatory environment

Questions to Ask:

• Who are your main competitors?
• What's your competitive advantage?
• How has your industry changed in 5 years?
• What threats concern you most?

Business model evaluation

For Retail Tenants:

• Sales per square foot benchmarks
• Customer acquisition strategy
• Online competition exposure
• Merchandise differentiation

For Restaurant Tenants:

• Concept uniqueness
• Operator experience
• Supply chain relationships
• Alcohol license status

For Professional Services:

• Client concentration
• Contract lengths
• Growth trajectory
• Partnership stability

Track record investigation

Reference Checks:

Site Visits:

• Visit existing locations (if applicable)
• Observe operations, customer traffic
• Talk to customers informally
• Evaluate maintenance and presentation

Pillar 3: Character assessment

Background investigations

For Principals and Guarantors:

• Criminal background check
• Civil litigation search
• Bankruptcy search (past 10 years)
• UCC filing search
• Professional license verification
• Media/news search

Red Flags:

• Pattern of litigation
• Previous tenant disputes
• Fraud or dishonesty charges
• Undisclosed bankruptcies

Interview assessment

The numbers don't tell you everything. When you sit across from someone, watch for:

Professionalism:

• Punctuality and responsiveness
• Quality of submitted materials
• Willingness to provide information
• Transparency about challenges

Business Acumen:

• Understanding of their business model
• Realistic projections
• Awareness of risks
• Plans for various scenarios

Partnership Potential:

• Communication style
• Problem-solving approach
• Long-term orientation
• Alignment with property positioning

Pillar 4: Structural protections

Lease terms that protect landlords

Security Deposits:

Letter of Credit (preferred for larger tenants):

• Irrevocable, unconditional
• Payable on demand
• Evergreen or minimum 60-day notice of non-renewal
• From acceptable financial institution

Guarantee structures

Full Guarantee: Guarantor liable for entire lease term

• Required for: startups, weak credits, first-time operators

Burning Guarantee: Reduces over time as tenant performs

• Example: Full for years 1-3, 50% years 4-5, burns off year 6
• Appropriate for: established tenants with moderate history

Rolling Guarantee: Covers defined period rolling forward

• Example: Always guarantees next 24 months of rent
• Balances landlord protection with guarantor exposure

Lease covenants

Build in provisions that give you early warning before a tenant goes dark:

Financial Reporting Requirements:

• Annual financial statements within 90 days of fiscal year end
• Quarterly sales reports (percentage rent deals)
• Notification of material adverse changes
• Right to audit (with reasonable cause)

Operating Covenants:

• Minimum hours of operation
• Required insurance levels
• Maintenance standards
• Permitted use restrictions

Default Provisions:

• Grace periods appropriate to tenant size
• Notice requirements
• Cure rights
• Remedy options

Insurance requirements

Minimum requirements for tenants:

Landlord should be named as additional insured on liability policies.

The due diligence checklist

Documentation checklist

From All Tenants:

• Completed rental application
• Certificate of formation/good standing
• Operating agreement or corporate bylaws
• List of principals/owners
• Business plan (for new operations)
• Trade references (minimum 3)
• Landlord references (current + 2 previous)

Financial Documentation:

• Business tax returns (3 years)
• Business financial statements (3 years)
• YTD financial statements
• Personal financial statements (guarantors)
• Personal tax returns (2 years, guarantors)
• Credit report authorization

Verification Documentation:

• Photo ID (all principals)
• Proof of insurance
• Permits/licenses (as applicable)
• Professional certifications (as applicable)

When to walk away

Some tenants look promising and the right answer is still no. I've passed on plenty, and I've never regretted the ones I walked from.

Definite Pass:

• Unwilling to provide financials
• Cannot verify past landlord references
• Unexplained gaps in business history
• Fraud or dishonesty in background
• Financials significantly misrepresented

Proceed with Caution:

• Startup without relevant experience
• Single-location national franchise first-timer
• Significant industry headwinds
• Below-average credit metrics
• Heavy competition in trade area

The cost-benefit of due diligence

Time Investment: 10-20 hours for comprehensive review

Cost: $500-2,000 for third-party reports

Value Protected: Potentially millions in lost rent, legal fees, and carrying costs avoided

Lornell Real Estate provides comprehensive leasing advisory services, including tenant evaluation and lease negotiation. Let our experience protect your investment. Contact us before signing your next lease.

Sources & References

• CBRE
• Cushman & Wakefield
• National Association of Realtors

This article cites data from the sources listed above. For the most current figures, consult the original publications directly.

Data current as of publication date. Market conditions, rates, and regulations may have changed. Consult a qualified commercial real estate professional before making investment decisions.