Although landlords often ask for security deposits on commercial leases, such deposits aren’t legally required. In fact, you can often negotiate them. Unfortunately, too many business owners don’t know that and willingly pay the deposit, without negotiating the amount or the terms. Your goal as a tenant is to pay as little deposit as possible—no deposit at all is best. Deposit money, which generally doesn’t earn a penny in interest, can better serve as working capital for your business rather than security for your landlord.
Viewpoint: Tenant vs. Landlord
From your standpoint as a tenant, paying a security deposit confers no advantage or benefit. It ties up your money—money that many landlords try hard not to give back to you if you don’t renew your lease.
From a landlord’s perspective, a security deposit makes perfect sense; it gives the landlord a chance to recoup some of the money spent on bringing in a new tenant. Acquiring a new tenant can be an expensive proposition for a landlord for several reasons. Any deposits collected can help to offset the following costs:
- The commercial space may have sat vacant for some time, bringing in no income for the landlord.
- The landlord may have to offer monetary inducements, such as a tenant allowance or free rent to lease their space.
- Landlord’s work may be required to make the space suitable for showing and leasing.
- The landlord has to pay real estate commissions to agents (in most cases). These fees can cost a pretty penny and are typically 5% of a tenant’s total base rent. Remember, however, that the landlord’s commission costs are not your responsibility.
Document, Document, Document
Regardless of how the landlord and their agent handle the incoming tenant deposit, a credit to the tenant remains on the landlord’s books. This credit should be clearly documented in your lease agreement because it’s the record of your deposit. If the landlord sells the building, you may receive an estoppel certificate confirming the basic terms of your lease and any outstanding obligations, including the amount of the security deposit currently being held by the landlord. This estoppel certificate is a document confirming information as correct, and it’s commonly used to verify facts for a third party.
Estoppel is a judicial device in common law legal systems whereby a court may prevent, or “estop” (a person who performs this is estopped) a person from making assertions or from going back on his word. Estoppel may prevent someone from bringing a particular claim, particularly if a promise unsupported by consideration is being relied on by the other party. (Wikipedia)
Landlords typically want to hold the deposit until the lease agreement terminates and the tenant vacates the premises. Holding the deposit for the entire lease term happens for several reasons. If the tenant causes damages to the premises, the landlord can deduct those repairs from the deposit. If the tenant doesn’t remove their leasehold improvements, the landlord may pay a contractor to do so and deduct that cost from the tenant’s deposit. If base rent remains owing or if the landlord has under-budgeted or overspent on the operating costs, a Common Area Maintenance (CAM) reconciliation balance can be outstanding which the landlord may also deduct from the deposit. If the tenant doesn’t return the keys or clean the premises, it can result in a deposit deduction—all depending on the wording of the deposit clause.
Even though landlords and real estate agents may tell you that the purpose of the security deposit is to provide the landlord with protection if you default on the lease agreement, the real reason is to offset the landlord’s commission being paid out to the real estate agents or other up-front costs.
It’s All About the Details
The deposit clause in your lease agreement can contain specific or very loose wording dealing with the details of the deposit. Keeping the wording simple isn’t a good idea. You want to cover every detail about the deposit—especially when you will get it back—to prevent arguments down the road. Simply stating that the deposit is “X amount of dollars or two months’ rent to be held for the term” isn’t nearly enough information. Ask the landlord the following questions:
- How much is the deposit?
- Where is the deposit applied?
- Is the deposit fully refundable?
- When will the deposit be returned?
- When would the deposit not be returned?
On a final note, although one to two months’ rent is an industry standard for commercial properties, the actual amount can vary dramatically. Deposit amounts vary for any number of reasons including your financial strength, the existence of a personal guarantee, the size of landlord inducements, competing offers from other landlords, and the strength of the landlord’s position.
For a copy of our free CD, Leasing Do’s & Don’ts for Commercial Tenants, please e-mail your request to JeffGrandfield@TheLeaseCoach.com.