Ecommerce Start-ups and Covenant Strength when letting Commercial Property.

Before letting commercial property, a landlord or their agent will have a look at a potential tenant’s covenant strength. Effectively the landlord is assessing the financial stability and profitability of the business to ensure the prospective tenants can pay the rent. Traditionally this is done by looking at accounts and doing a reference check. This process is called a covenant strength check.

As far as a landlord is concerned covenant strength is important for two reasons

1.     A good covenant will reassure a landlord that the tenant can pay the bills and is likely to be there for the duration of the lease.

2.     More importantly if the landlord ever wants to sell the business with the tenant in situ the better the covenant the more the landlord will achieve for the property as the potential purchaser can be assured of a steady and timeous income stream

Tip from Shaf:  A good covenant strength can be more powerful, or valuable to the landlord, than a higher rent, as the value of the property will be higher and the landlord will be able sell the asset for a higher price

This is all fine and well when it comes to blue chip investments and traditional retailers, however it will not work in the nimble worlds of ecommerce start-ups. When I started my company E-Net computers we were looking for warehousing and no one wanted to rent space to us as we were a start-up. The business had been incorporated for just over a year and had been trading for a few months. No-one wanted to listen to us when we said our products would dominate the internet sales channel and our turnover  would be  tens of millions of pounds over the next few years, which incidentally it did go on to do! Imagine what a great covenant it would have been for a landlord to sign up E-Net for 15 years! Finally, we ended up buying the building off the landlord for over £1m with surplus cash flow that our trading business threw off.

A decade and a half later, my Commercial Property investment company owns a substantial portfolio throughout Scotland. A large percentage of our portfolio is small industrial units such as the ones we own at  e-netpark, not surprisingly most of the enquiries come from start-up online retailers, an area of the market we actively target. Unfortunately, not all start-ups are successful. As a result of this we really needed to develop a system that could determine which online tenants were going to be successful. After all, online trade accounts for around 15pc of total retail sales in Britain and is growing fast. The £10bn generated by online sellers is expected to double to £20bn in the next five years as more entrepreneurs set up shop.

Due to my background in e-commerce, I was invited to speak at an e-commerce event organised by Iwoca founder Christoph Reich. Iwoca, the darling of the FinTech world, lend money to internet retailers, who are predominantly eBay and Amazon traders.  I used the opportunity to have several discussions with Christoph over how Iwoca makes lending decisions. The jist of it is that Iwoca has built a model which assesses the risk of lending to internet retailers based on much more than accounts.  They look at the quality of the potential borrowers; customer feedback; how successful they are at attracting business through social media; their product ranking in a search query and the quality of reviews left by customers. Public feedback is the only way to build trust when you’re an online seller. If you lose your reputation, then you have to start offering your merchandise at a lower price to win sales. The better the feedback, the better a business is run and the higher the margin is going to be from that business.

Over the last few years, we have developed our own algorithm to vet potential tenants so we check which internet retailers are going to be successful, and touch wood, our system has got it right in every instance so far. Much the same as Iwoca, we look at a customer’s performance on marketplaces such as Etsy Amazon and eBay as well as their own website.

Now clearly, I’m not going to share my algorithm with you - unless of course you pay me a lot of money - but I can give you general pointers to assess how a tenant runs their business and from there you can make a calculated decision as to the long-term viability of a potential online tenant.

A good tool for performing a basic search of an eBay seller’s business is Terapeak. Terapeak will provide a whole host of information about an eBay seller. Simply type in the name of a seller and it will provide you with information such as the retailer turnover, their best selling products, how they compare to other retailers who sell the same products, etc.  Click  this link to see the depth of information available.

Other due diligence that a landlord can do for Amazon sellers is to see their traction on Amazon Seller Central – again, that offers a wealth of information. Unlike Terapeak, Seller

Central is not available except to the seller, so you will need your potential tenant’s permission to access it.

Furthermore, you can check out the client’s online presence by looking at their social media presence and read the review left on sites such as trust pilot. The more proactive they are in dealing with customer enquiries, the more they are passionate about selling on the net.

Finally, remember to check their feedback on eBay - simply log onto eBay and click on the feedback link. Again, check their feedback on Amazon.

Tip from Shaf: E-commerce is going to continue to take market share from traditional bricks and mortar shops. It is vitally important that if you are renting industrial space that you target this market and develop procedures such as the ones I have identified above in order to pick the future winners.