Negotiating the Security Deposit in Your Commercial Lease
Having to rent a new office suite, retail space, or commercial property in general, requires a lot of research to make sure that the space and location fit your business operations and potentially attract your target consumers. Usually, when you find the perfect commercial property, you immediately sign the lease contract. However, it also requires a bit more than that – a hefty security deposit. That means you’re going to have to fork over quite a bit of money every time you lease a commercial property.
For starters, a Security Deposit is a payment that a tenant makes to the landlord when signing a commercial lease. It isn’t just some random fee that the landlord charges you every time you rent their commercial space, it serves as a hedge in case you don’t hold up your end of the deal or against any future unknown occurrences that may happen to their property.
Typically, these funds are referred to as “damage deposits”. These funds serve as extra cash that a landlord can, and have the right to use in case the unit gets damaged or you are unable to pay your rent.
In commercial leases, a security deposit is typically equal to one (1) month of rent – can be higher depending on the landlord and is paid upfront when a tenant signs the lease. This will then be kept by the landlord for the whole term of your lease and eventually returns it when your lease expires as long as you keep the property in good condition while adhering to all lease obligations.
So what will be your options and how will you negotiate for the lowest possible security deposit?
- With a Reasonable Request
Paying the rent itself can be a costly expense in your monthly budget, let alone paying twice the said amount – in the form of a security deposit after you have signed the commercial lease. However, this can be sometimes be negotiated.
Some landlords do not accept this type of request and would make you pay a security deposit equal to one (1) month of rent. You can’t blame them as they are letting you, a complete stranger, use their space hoping that your business is successful and that you are, as promised, a good tenant who will not damage their property. It is completely understandable as they are protecting their investment. However, there are some landlords who may be willing to meet you halfway.
Try to settle on a reasonable amount in which you think your landlord could accept your offer. Some landlords would meet you in the middle if you request a security deposit equal to 80% of your monthly rent. This number can still be lowered depending on how you negotiate his terms.
- Consider a Set of Conditions
If you are a tenant with good credit standing and financial history, then your landlord may be able to give you some leniency on the security deposit amount. This gives them some sort of confidence that you will be able to pay your monthly rent in due time.
Rule out the market’s supply and demand, too. Some landlords may not be aware that the competition in the area for attracting good tenants is high, and that you chose their property even though you were presented with a lot of viable options.
Consider also the history of the commercial property. If the property you are planning to lease has been vacant for a long time, it means it’s not attractive to consumers. You can try to negotiate with the landlord and cite this fact, they may give you some room for negotiation.
- Through a Letter of Credit
As mentioned above, security deposits can be higher than a one-month rent. Unlike residential leases, there aren’t any laws that govern how much a landlord can charge for a security deposit in a commercial lease. Thus, your landlord may ask for a very large deposit.
If you are unable to pay the amount of security deposit your landlord asks you to, another option is through a letter of credit. A letter of credit, or “credit letter” is a document issued by the bank to serve as a guarantee for payment. However, this does not apply to all scenarios. A letter of credit is only eligible if you have built a strong relationship and good credit history with your bank. But if you have met all the requirements for the bank to issue a letter of credit, this can be a good strategy and solves the challenge of having to pay the large deposit upfront.
- Personal Guaranty Agreement
If the landlord asks you for a very large security deposit and you are not able to meet that amount after exhausting all your options, then you can negotiate for a personal guaranty agreement. This is a very risky option in negotiating a security deposit in your commercial lease as you are agreeing to seize your personal assets in case you are not able to adhere to your lease obligations. Personal Guaranty’s are very common and most tenants will have to sign one in order to lease commercial space.
To reduce your risk, an option is to find a strong business partner who could help you in the negotiation process. That means you don’t have to gamble most of your personal assets as he is willing to take half of the obligation.
If in such a case that you and your business partner would go for a personal guaranty agreement, do not take this lightly as you are putting your personal assets on the line. Hence, make sure to keep your end of the bargain.
Even after outlining all this information above, you may still have questions on leasing and security deposits. Please feel free to contact us anytime with your questions and concerns. The Leveraged CRE Investment Team at Commercial Properties, Inc. is here to help you achieve your investment and business goals.
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Phill Tomlinson is a commercial real estate broker with Commercial Properties, Inc. (CPI) in Scottsdale, Arizona, and owner of the Leveraged CRE Investment Team specializing in investment sales and tenant/landlord representation in the Phoenix and Scottsdale submarkets. Phill applies over 21 years of experience in the Real Estate industry helping investors and owners maximize their returns.
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