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Commercial Lease: What does Covenant Strength mean?

A landlord will want to make an assessment of the covenant strength of a potential tenant before agreeing terms to rent out a commercial property.  In other words, the landlord will want to assess your financial stability and profitability by looking at your accounts and taking up references.  The landlord will be making an assessment of your track record and whether your business can realistically afford the rent.

If you are taking a new lease you will be dealing direct with the landlord (albeit via their agent).  If you are taking an assignment of an existing lease the present tenant, as well as the landlord, may also want comfort on your covenant strength as the current tenant may be obliged, under the terms of the lease, to guarantee your payment obligations should anything go awry during  your tenancy.

Covenant strength is not just about giving the landlord reassurance that you can pay the bills and have a viable business it is also about the landlord maintaining the value of his investment.  If you own a  commercial premises as an investment but decide to sell with a tenant in situ you would want to be able to market the property on the basis that you have a regular income stream from a tenant with good covenant strength this will underpin or even enhance the value for someone buying the property as an investment.The potential buyer wil be more assured of steady income stream without the tenant defaulting on rental payments.  In fact, a good covenant strength can be more powerful, or valuable to the landlord, than a higher rent.   Consider high street retailers – if a shop unit occupied by a recognised national name came on the market its value is likely to be  increased because of the perceived strength – covenant strength – of the tenant.

As part of the process of verifying covenant strength the landlord will want to see your accounts, check credit ratings, take up credit references and other references (such as bank,  professional, trade or present landlord) and, if you are a company,  will carry out company searches.

If you are a prospective tenant you should bear in mind that the stronger your covenant strength the stronger your negotiating position as you will be the sort of tenant a landlord would value: a tenant likely to be able to afford the rent  – in other words a tenant with  strong covenant strength.

Feel free to call Jane Latham for an informal free, no obligation chat: 01225 287516

 

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