In commercial real estate, the quality of the tenant is often more important than the quality of the building. A mediocre property occupied by an investment-grade national tenant on a 15-year NNN lease is a more predictable investment than a beautiful building occupied by a local operator on a short-term lease. Understanding how to evaluate tenant quality is one of the most critical skills in commercial real estate investing.
Credit quality is assessed through the tenant’s financial statements, credit ratings (for public companies), and operational history. Investment-grade tenants — those rated BBB- or better by major rating agencies — have the financial strength to meet their lease obligations across economic cycles. Non-investment-grade tenants may offer higher initial yields, but the risk of default is meaningfully higher, particularly in recessions.
Evaluating Non-Rated Tenants
Many tenants in single-tenant commercial deals are not publicly rated. In these cases, due diligence involves reviewing audited financial statements, assessing the tenant’s industry position and competitive moat, evaluating store-level performance (for retail), and understanding the replacement cost of the space if the tenant vacates. A strong real estate location — high traffic, limited competing supply — provides a safety net if tenant performance deteriorates.