Each individual property you see on Modiv’s Portfolio page didn’t appear there on a whim or by chance. Rather our portfolio is the result of a thorough underwriting process that looks at all aspects of a deal. In particular, we seek single-tenant net lease (STNL) industrial, office and retail properties leased to credit-worthy tenants via long-term agreements as the foundation of our portfolio.
When we consider new property acquisitions, our initial due diligence focuses on commercial properties that we believe have the best opportunities to generate consistent rental income with the potential for long-term appreciation.
One of the biggest risk factors with commercial real estate is the financial stability of a tenant that is occupying a property. That’s why among the multitude of criteria our seasoned investments team conducts their due diligence on, credit-worthiness of the tenant is one of the top factors we examine in order to help our investors feel confident about their investment.
Here’s what you need to know about credit ratings and how they may affect commercial real estate investments.
What is a corporate credit rating?
Many corporations issue bonds (debt securities) that they use to invest in company growth and for other general corporate purposes. Typically, investors of these bonds receive interest payments (coupon rates) on the principal amount and at the bond’s maturity date they are paid back the principal.
Corporate credit ratings are opinions published by independent ratings agencies that determine the ability for these debt-issuing corporations to meet their financial obligations as they come due, including paying back creditors when the principal is coming due and meeting required quarterly interest payments. They indicate the overall financial health of the company and are forward-looking.
It is important to remember that credit ratings are not a guarantee that a company will meet its obligations, but rather denote the likelihood of defaulting, and there may be extenuating circumstances that impact the financial viability of a company. For example, a company rated AAA is considered much less likely to default than a company rated BB/Ba or lower.
Three of the most commonly used ratings agencies are Moody’s, Standard & Poor’s (S&P) and Fitch. Each agency has its own rating system with different scales, but equivalencies can be drawn between the systems. Tenants with an investment grade rating are considered to be credit-worthy.
Why are high credit ratings for tenants important in commercial real estate?
Investment grade credit ratings generally reflect a more stable corporate tenant. Real estate investors, for example, may feel more confident that an investment-grade tenant (as opposed to a non-investment grade tenant) is less likely to default on rental payments or go out of business.
Lenders also look at credit ratings during their underwriting process and may possibly offer larger loans with better terms if a property is leased to a tenant with a high credit rating. Tenant creditworthiness is one of the top factors when determining a loan-to-value ratio for a single-tenant property.
A tenant’s credit rating may help increase the sales price of a property should the owner decide to sell, when compared to similar properties without credit tenants occupying the building, because purchasers are more willing to purchase a property with an investment grade credit rating.
Remember that not all REITs and real estate funds are created equal, so it’s crucial that a seasoned team of professionals has the best interests of investors in mind when building a strong portfolio. It’s also important that you conduct your own due diligence before investing. Keep in mind that, like all investments, investing in real estate or other alternative assets is not immune to risk including illiquidity and complete loss of invested capital, and there are no guarantees dividends will be paid or tenants will pay their rent.
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The views and opinions expressed in this commentary reflect Modiv Inc.’s (together with its affiliates, “Modiv”) beliefs and observations in commercial real estate as of the date of publication from sources believed by Modiv to be reliable and are subject to change. Modiv undertakes no responsibility to advise you of any changes in the views expressed herein. No representations are made as to the accuracy of such observations and assumptions and there can be no assurances that actual events will not differ materially from those assumed. The forward-looking statements in this paper are based on Modiv’s current expectations, estimates, forecasts and projections, and are not guarantees of future performance. Actual results may differ materially from those expressed in these forward-looking statements, and you should not place undue reliance on any such statements. These materials are provided for informational purposes only, and under no circumstances may any information contained herein be construed as investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any Modiv program or offering. Alternative investments, such as investments in real estate, can be highly illiquid, are speculative, may not be suitable for all investors, and there is no guarantee that distributions will be paid.