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2020 threw us all a serious curveball with the pandemic, particularly as it relates to risk management. It even made risk factors you had a healthy, experience-based gut-feeling for seem much less certain. In this new reality, commercial real estate professionals such as property, asset, lease and finance managers are still tasked to come up with forecasts, budgets, think on their feet and confidently make decisions and recommendations. While commercial real estate professionals such as property, asset, leasing and finance managers are used to living and breathing data and risk, more and more realize that traditional data is not enough. What’s missing is a strong risk assessment tool that looks beyond the lease data you have at your own disposal and is able to extrapolate, benchmark and predict different risk factors associated with your office tenants (or “Lease-Risk” as we call it). Getting closely acquainted and comfortable with your property’s lease-risk is the only way to move forward across the uncertainty. Doing this accurately requires two main elements: You need a data mindset that expands beyond what has traditionally been utilized, and the data needs to be dynamic by nature as opposed to one-time due diligence done at signing, or periodical lease health “checkups”. Download the free worksheet to assess your current lease-risk assessment process and read on to learn about the 5 risk factors you need to add to it.

How to create your 2020-proof risk assessment methodology:

1. Select Your Focus Risk Factors

Review your existing risk factors and ask yourself: are they still relevant? How often do I go back to them – is it frequent enough? What risk factors am I missing? Next, decide on a set of risk factors, data sources and frequency. Here is a list of 5 often-overlooked lease-risk factors that you should strongly consider adding to your list:

Work from Home

The shift to working from home is one of the risks that has gotten a lot of attention due to the pandemic, and rightly so. While Google’s announcement that it will extend WFH has caused much concern, the truth is that WFH risk will be very closely related to your tenant’s industry. When calculating this important risk, keep in mind that most companies will have a hybrid WFH-office model, and ask yourself how dependent is your tenant on an office. For example, tech companies – which tend to be global and more used to working remotely – will get a higher WFH risk score than law firms.

Headcount

What makes your tenant’s company headcount interesting isn’t the number- that is only relevant for calculating space. What is interesting and something to pay attention to are the fluctuations in headcount as that can be a strong indicator of your tenant’s financial health and growth trajectory, or vice versa. We recommend the use of resources like LinkedIn and Glassdoor to track headcount changes in order to stay informed regarding recruitment, hiring freezes, layoffs and furloughs.

Industry Mix

When acquiring new tenants for a building, it’s advisable to diversify the industry mix and focus on lower risk industries. Monitoring and measuring the risk factor for existing and new tenants is two-fold: First, follow press related to the specific industry they are in and assign each tenant a risk score. After gaining a deeper understanding of your building’s existing industry risk makeup, make sure to diversify and maintain a healthy industry mix of low, medium and high-risk industries. Since industry risk may fluctuate in uncertain times, we recommend periodically evaluating and updating your industry mix risk score.

Rent Burden

When assigning and calculating rent risk, it’s important to not only be aware of the market rent, but also understand how it corresponds with your tenant’s financial wellbeing. Rent burden is assessed by calculating the percentage of rent from your tenant’s profits (which you can research independently). If the rent represents more than 5% of your client’s profits, see this as a red flag, and take this risk factor to heart – as it’s very likely to affect your risk of the tenant asking for rent relief, terminating or not renewing the contract.

Financial Stability

Your tenant’s financial status, including their expenses, revenue and profitability, are an integral part of a due diligence process. Even more important than their financial standing at any given time, is your client’s financial stability. Tracking their stability across media mentions and market intelligence platforms (like S&P, or in the software industry – Pitchbook) is essential to understanding how your tenants’ finances are trending and how much risk they might represent for you.

2. Understand the Risk-Factors’ Weight and Impact

After having carefully considered the different risk factors and their corresponding impact on your NOI, it’s time to calculate the risk level. Risk should be calculated at the lease level and not just on the tenant level. Lease Risk is a derivative of risk that is derived from a combination of the lease structure, the tenant situation and the local market – the lease trifecta. Not all risk is created equal. Different risks impact your bottom line differently – i.e., different risk factors have a different weight and should be regarded in relation to their impact on your business. On the tenant side, consider that even similar risk factors might differ in their impact on your bottom line. Keep in mind that a tenant’s company may be successful and still represent risk. Case in point, Starbucks’ letter to landlords demanding a break on rent for the next year, citing the coronavirus pandemic to pursue lease concessions. To understand how the impact of a single lease-risk factor mixes with your entire portfolio risk, it’s essential to always look at the bigger picture – the asset or portfolio level – and assign different weights to different risk factors and different tenants, based on market trends, industry or property. Evaluating risk is a subjective job and different people might rate the risk for the same lease differently. Therefore, setting a single framework for lease-risk evaluation is a must to ensure standardization.

3. Never Stop Learning

Lastly, the key is to never rest on your laurels. This is where it becomes more complicated. Keeping track of such a wide net of data and constantly learning and iterating to change the weights of different risk factors is where AI capabilities excel over us as humans (albeit talented and data-oriented ones). In case you are manually assigning the risk score per factor, it’s crucial to constantly be questioning the weight of each factor, how it relates to the tenant’s specific industry, company size and other unique characteristics, the evaluation frequency and the data sources you rely on. As you are collecting and aggregating this data on an on-going basis, you will need to determine how all of these elements impact your property’s overall lease-risk. Investing in a powerful AI Lease Risk assessment tool that will be constantly working in the background will allow you to focus on your leases’ success.