A credit rating is an opinion or classification of a debtor’s credit risk. It is the grade that indicates the likelihood that a business will default on its financial obligations. Large corporations that issue debt (corporate bonds) are rated by the rating agencies. There are also instances where private companies or smaller corporations could be rated.
For real estate investors or lenders, credit ratings are generally used to determine the probability that the corporate tenant will default on their financial obligations under a lease. If a corporation is given an “investment grade” credit rating, they are considered a “credit tenant”. A credit tenant is believed to have a low risk of default under their lease.
“Credit” tenancy in real estate transactions tends to create more options for investors. Although it is only one variable, the more credit tenants you have or the higher credit rating your tenant has, there may be a greater opportunity to secure lower rate, longer term and potentially higher leverage financing.
Two ratings agencies that rate the credit of major corporations are Standard & Poor’s and Moody’s. Outlined below are the ratings issued by Standard & Poor’s as well as which ratings are considered acceptable for tenants of leased investment.
For Standard & Poor’s the ratings are as follows:
AAA: “Extremely strong capacity to meet financial commitments”
AA: “Very strong capacity to meet financial commitments”
A: “Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances”
BBB: “Adequate capacity to meet financial commitments, but more subject to adverse economic conditions”
BB: “Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions”
B: “More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments”
CCC: “Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments”
CC: “Highly vulnerable; default has not yet occurred, but is expected to be a virtual certainty”
C: “Currently highly vulnerable to non-payment, and ultimate recovery is expected to be lower than that of higher rated obligations”
D: “Payment default on a financial commitment or breach of an imputed promise; also used when a bankruptcy petition has been filed or similar action taken”
Ratings from AA to CCC can also have a plus (+) or minus (-) sign to show relative position within the ratings categories.
Only corporations that are within the “investment grade” group above will be considered credit tenants. As an investor in net leased properties, you will want to stay away from tenants with anything lower than an investment grade rating (BBB-).
*source – ratings and descriptions for Moody’s and S&P Global