Low insolvency rate a red flag for real estate agents, says Equifax boss

Record-low insolvencies this year were a red flag that warned commercial real estate agents of an increased risk of lease defaults, a financial industry leader has warned.

Some 58% fewer bankruptcies had been reported year-on-year due to Covid-related support from government and financial institutions, said Scott Mason, general manager of commercial property services at Equifax.

The pending withdrawal of JobSeeker, the end of bank loan deferrals and a re-tightening of director obligations would threaten the immediate future of many companies, he told a webinar of more than 300 agents.

“While on the surface a record-low rate of insolvencies would appear good news, it isn’t,” said Mr Mason. “Many more companies would have gone bankrupt without Covid assistance.”

He said speculating on how many enterprises would eventually liquidate had become the “topic of the year” in the financial sector.

“Real estate agents need to be more diligent than ever,” said Mr Mason. “The number of insolvencies we’re going to see in the next six months will be really interesting.”

On the webinar, organised by REI Forms Live, agents were recommended to go beyond normal due diligence practices when checking the credentials of prospective tenants.

While running director reports from the Australian Securities and Investment Commission (ASIC) had been considered sufficient research, the heightened risk of insolvencies meant agents needed to dig deeper on behalf of landlords.

Equifax provides a variety of in-depth reports that focused on a company’s payment record, trading history and directors’ performance. The service included reports that scored an enterprise as a credit risk. These are available through REI Forms Live.

Mr Mason said Equifax was the largest broker of commercial risk reports and also held data across all industry sectors covering 2.9 million commercial entities, one million companies and 550,000 trusts.

Deeper research would alert agents to “zombie” and “phoenix” companies, which existed only because of the Covid relief measures, said Mr Mason.
A “zombie” company is one that requires bail-outs to exist, or can pay interest on a loan but not reduce its principal.

A “phoenix” is an enterprise that rises from the ashes of liquidation, or has been abandoned to avoid paying debts. It then re-emerges to begin the same business but without the debt, leaving suppliers, sub-contractors and landlords high and dry.

The National Head of Property at legal firm Colin Biggers & Paisley, Rhett Oliver, told the webinar that such companies could be difficult to identify.
Common behaviours included failure pay rent or carry out any repairs and maintenance obligations that had been set out in a lease.

Agents should also watch for tenants that suffered drops in turnover, a reduction in employee numbers or ceased trading on the premises.

“You might also see some strange behaviours,” said Mr Oliver, “such as tenants asking for a new entity to go on the lease but with the same directors’ names but different ABN.”

Agents needed to remember they were obligated to “act in the best interests of their client”.

“They must show due care, skill and diligence,” said Mr Oliver. “Agents need to verify facts and materials that are presented to them.”

Failure to meet these obligations exposed an agent to compensation claims from a client and disciplinary action that could result in restrictions on their licence, or suspension or loss of their licence.

As part of any due diligence, Mr Oliver recommended agents seek a corporate structure diagram to get a “picture of substance” of a prospective tenant. Doing additional due diligence through ordering reports that took a deeper look at the credit rating of a business, its directors and associated entities could all be part of an important paper trail.

They should undertake company and credit searches, using ASIC and other providers, and ask prospective tenants for financial information, such as a balance sheet and cash flow projection that had been signed off by an accountant.

The chief economist at REA Group, Nerida Conisbee used the plight of Melbourne’s CBD as an example of how business districts could lose tenants quickly. It had lost 300 shops because of Covid lockdowns.

The balance of negotiating power in retail had swung from landlords to the tenants as a result. “Retail has always been seen as incredibly safe but now it has become a problem,” she said.

Office space was suffering similar pressure with “quite high rates of vacancies and drops in rent”, she said.

This was not true for every capital city, however. While Melbourne struggled and Sydney continued to recover, Perth was enjoying a “new mining boom that is flowing through to the office space market”. Hobart was “doing really well”, too.

Industrial space had also benefited during Covid because of the increase in online shopping and the infrastructure needed to support that trend.

Ms Conisbee predicted that three economic sectors – hospitality, education and tourism – would continue to struggle, and some tenants in those lines of business might find it difficult to pay rent.

To view the entire webinar, please visit https://vimeo.com/522125136

Equifax Commercial Risk reports can be found inside your Forms Live, Realworks or REI Forms Live account.