• 08 Feb 2021
  • 5 min read
  • By Realworks

Beware of 'Zombie' and 'Phoenix' commercial tenants

Commercial Real Estate, Tenants, Covid 19, Risk

Real estate agents have been warned to watch for 'zombie' and 'phoenix' companies seeking new commercial leases in the aftermath of the COVID-19 crisis.

Businesses that can only survive with pandemic-related government support are referred to as zombies that are unlikely to live beyond their hand-outs or complete a multi-year commercial lease. Phoenixes are just as unreliable - failed enterprises re-birthed under new names by their same directors.

Agents were urged at a webinar held by the REIQ and electronic forms specialist, Realworks, to double down on their due diligence of prospective tenants.

"You need to be sure the tenant is sustainable beyond government support," warned Antonia Mercorella, the chief executive officer of the REIQ. It is the responsibility of agents to ensure new tenants "have the financial capacity to meet their obligations under the lease." This is the fiduciary duty of every agent on behalf of their client.

Realworks has integrated new credit reports from Equifax, the global data, analytics and technology company and leading provider of credit information and analysis in Australia, to help agents conduct financial and credit checks on companies and their directors. The head of Equifax B2B Commercial, Andrew Castledine, told webinar participants 57% of companies that went into external administration have no prior adverse events recorded on their credit file. "With CBD commercial tenancies experiencing high vacancy rates with the pandemic, there is a temptation to just find a tenant, but now more than ever, agents need to be careful of phoenix companies that have become financially unviable and then re-emerged under a different name," Castledine said.

Agents need to be careful of "phoenix" companies whose directors had "run them into the ground" and then re-emerged under a different name, he said

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Equifax and Realworks had formed an alliance to help protect agents and their clients from prospective tenants who had little chance - or no intention - of fulfilling the terms of their lease. Mr Castledine said the common work practice - to conduct an ASIC search and obtain director guarantees - was insufficient due diligence in today's environment. Instead, agents should request a Trading History report using the REI Forms Live system, which is linked directly to the Equifax database. This reveals ASIC information, plus the credit histories of the company, its directors and any owners who stand to benefit.

Equifax provide a profile and credit score for each director. "We trend and track how companies are paying others in the market," said Mr Castledine. "We can predict an adverse event occurring." An increasing number of agents are beginning to use the service, which indicates unease with some prospective tenants currently seeking commercial space.

Julie Ryan, REIQ Commercial and Industrial Chapter Member said several areas within the commercial property sector were enjoying a resurgence of interest from investors and companies that had benefited during COVID-19. Low interest rates and continued unease about the share market were encouraging buyers into the market despite negative media commentary, and demand for industrial space was "going through the roof", driven by online retailers that supply goods through Amazon and eBay, she said.

While major shopping centres had reported a 40% drop in foot traffic during the early stages of the pandemic, suburban retail strips were booming and regarded as excellent investments, Ryan said. National retail chains in the major centres had renegotiated their leases in a "nanosecond", but concern remained for small businesses that had not reset their lease terms. According to Ryan, some are in a "world of pain" and "burning through their life savings to stay alive". Smaller retailers like this are at risk of becoming zombies. "They are neither dead nor alive," she said. "A business struggling pre-Covid has been given a lifeline by Jobkeeper. Superficially, the staff are still there, but in reality, these businesses are being propped up artificially."

Agents needed to learn ways to detect tenants in this predicament and act before State and Federal payments ceased. The number one clue that a business might eventually struggle to meet its lease terms is when they're occupying more space than they now need. However, it's still vital to work co-operatively with tenants who were struggling. "Making them the enemy is not productive," said Ryan. "We should engage with them at a human level."

Ryan said agents should be constructive, and she offered an example during the webinar in which a tenant had given their landlord a licence to sub-let space in the hope it would subsidise their own rent. "Building owners have real problems, too," said Ms Ryan. "Their borrowings and loan-to-value ratios are impacted by rates per square metre. We must make sure we don't create an enormous problem for owners later on."

Mercorella echoed the need for a human approach to ailing tenants. "This is a difficult balancing act for agents," she said. "It's very easy to say, 'we have a contract', and set out a tenant's obligations. Agents have a fiduciary obligation, so they must act in the client's interest and be responsible for who they put in a building. Where we've landed is a reasonable position. Humanity is what we have seen."

Equifax Commercial Risk reports can be found inside your Realworks account here. To watch a replay of the aforementioned webinar, click here.

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