By Gary Richetelli
Seasoned commercial property investors have a sixth sense for spotting problematic tenants: inconsiderate neighbors, financial deadbeats, nonconforming users.
Landlords newer to the business don’t have the benefit of experience. If you’re worried about unwittingly allowing foxes into the henhouse, look for tenants that exhibit these red-flag behaviors:
1. They’re using a sham company. Unscrupulous tenants sometimes use sham companies to disguise their true identities. Before formalizing a lease, do your due diligence, up to and including confirming the identities of all named officers and cross-checking state business registers.
2. They struggle to pay utilities. Unfortunately, this only occurs once problem tenants are safety ensconced at your property. But it’s nevertheless an important early red flag that no commercial landlord should ignore. Unless it’s impractical to do so, avoid folding utilities into your tenants’ rent—you’ll have an easier time spotting cash flow problems this way.
3. They resist personal guarantees. Require commercial tenants to personally guarantee their lease, period. This is a basic but crucial legal step that can save you thousands of dollars on a broken lease. Principals who resist very likely have their reasons—and not good ones.
4. They haven’t been in business very long. Be wary of companies that haven’t been in business very long, even if the principals provide personal guarantees and pass their credit checks with flying colors. Young businesses are inherently unstable, and therefore more likely to skip out on a commercial lease.
5. They have shoddy or spotty references. Avoid tenants who can’t produce positive references on demand.
Limiting the Damage From Bad Tenants
The best way to avoid dealing with bad tenants is to thoroughly vet all prospective tenants.
Unfortunately, this is easier said than done. In challenging commercial markets with low occupancy rates, it’s tempting to look the other way and rent to anyone who can come up with a security deposit. Likewise, landlords with multiple properties, competing obligations, or thin staffs often struggle to keep up with the administrative side of their profession, including tenant vetting.
For the sake of argument, let’s assume that even the most careful landlords allow the occasional problem tenant to slip through the dragnet. Once you have a bad tenant on your hands, what can you do?
Draft an Ironclad Lease Agreement
Your first move—even before the first indication that you have a problem tenant on your hands—is to hire or retain an experienced commercial real estate attorney to draft an ironclad, owner-friendly lease agreement. The added expense is well worth it. If you’re able to prevent even a minor financial loss with a well-drafted agreement, the contract will likely have paid for itself.
If you’ve retained a competent attorney familiar with the laws in your jurisdiction, your lease should include every realistic eventuality. In other words, it should provide you with every opportunity to formally evict a problem tenant.
That said, commercial tenants enjoy robust legal protections in most states. Evicting problem tenants is therefore not a straightforward matter. For simplicity’s sake, let’s look at the most common way to incentivize bad tenants to change—and to get rid of them should they refuse.
Evicting a Tenant for Unpaid Rent: Basic Procedure
1. Determine the tenant’s ability to make good. Eviction doesn’t need to be your first response. Before going any further, evaluate your prior relationship with the tenant and determine whether they’re likely to resolve the arrears. If a payment plan is realistic on any reasonable timeframe, it may be preferable to (and cheaper than) a drawn-out court battle.
2. Refuse partial payment or keys. If you judge that the arrears won’t be resolved amicably, resist the urge to cut a partial-payment deal or accept the tenant’s keys prematurely. Either step may preclude you from collecting additional rent.
3. Provide a notice of default. Serve your tenant with a written notice of default outlining the full amount owed and the date by which that amount must be paid in full.
4. Serve a formal eviction notice. If the stipulated due date passes without payment, serve your tenant with a written notice of eviction. Work with your attorney to schedule an eviction hearing in court.
5. Ask the court to lift the bankruptcy stay (if applicable). If the tenant files for bankruptcy, the bankruptcy court may grant a temporary stay of eviction. Consult with your attorney about petitioning the court to lift this stay. In many cases, the petition will be granted, and your tenant will be required to leave in a matter of days.
Have you ever evicted a problem tenant? How did the situation conclude?