Beware of ‘zombie’ and ‘phoenix’ tenants, industry leaders warn commercial agents

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 virus-related government support were zombies that will never live beyond their hand-outs or complete a multi-year commercial lease, industry leaders have said. Phoenixes were just as unreliable – failed enterprises re-birthed under new names by their same dodgy 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,” said Antonia Mercorella, the chief executive officer of the REIQ.

It was 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, Ms Mercorella said.

Webinar organiser Realworks has integrated new credit reports from Australia’s largest credit reporting agency, Equifax, 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 never had that event recorded on their financial history.

Agents needed to be careful of “phoenix” companies whose directors had “run them into the ground” and then re-emerged under a different name, he said.
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 Realworks system, which linked directly to Equifax’s database. This would reveal all ASIC information, plus the credit histories of the company, its directors and any owners who stood to benefit.

Equifax also provided 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 were beginning to use the service, which indicated unease with some prospective tenants currently seeking commercial space, he said.

Several areas within the commercial property sector were enjoying a resurgence of interest from investors and companies that had benefited in the virus crisis, said Julie Ryan, of Ray White Commercial Sunshine Coast and an REIQ chapter member.

Low interest rates and continued unease about the share market were encouraging buyers into the market despite negative media commentary. 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, Ms Ryan said.

National retail chains in the major centres had renegotiated their leases in a “nanosecond”, she said, but concern remained for small businesses that had not reset their lease terms. Some were in a “world of pain” and “burning through their life savings to stay alive”, Ms Ryan said. These smaller retailers were 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,” she said. “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 the hand-outs dried up.

The industry leaders urged agents to work co-operatively with tenants who were struggling. “Making them the enemy is not productive,” said Ms Ryan. “We should engage at the human level.”

Agents should also watch for tenants who were occupying more space than they now needed. This was the number one clue to a business that might eventually struggle to meet its lease terms.

Ms Ryan said agents should be constructive, and she offered an example 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.”

REIQ’s Antonia 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,” she said. “Humanity is what we have seen.”

Equifax Commercial Risk reports can be found inside your Realworks account. Go to: https://app.realworks.com.au/#reports