Security Deposits

In Closed Deals, Retail Thoughts on September 3, 2010 at 12:58 pm

Every retail lease negotiation I have worked on since Jan 1, 2009 (between my law office and CityRetail there are dozens, of which 16 have closed, i.e. a lease has been signed) has hinged largely on the amount of and/or form of security given by Tenant to LL in consideration of the Lease.

Most of us are familiar with security deposits in the residential game – you know, “first, last and security.” Residential tenants in the Boston/Cambridge market typically sign a 12-month lease and pay one month rent towards security.  Accordingly, if you bail and/or stop paying rent the LL has a one month cushion before it gets messy.  There is no formula in the retail game though and deal terms vary greatly:  the length of the tenancy can vary from 3 to 20 years (I’ve seen both in the 16 closed deals since ’09);  landlords often, especially in this market, will put some of their own money into improving the property, which can range from $10,000 to $500,000 (again, seen both); and the condition of spaces range from being ready for immediate occupancy (Lease executed and within days shop is open for business) to a 6-month plus period to obtain licenses and convert a cold-dark space into an occupiable space…  You get the point – lots of moving pieces and no deal is the same.

So then, how have I seen Security handled?… 16 different ways.  Security has been in the form of cash, a letter of credit, a security interest in another piece of real property and/or tangible asset(s), a personal guarantee, etc… (read more)

Generally, when risk goes down for the LL, security requirements should go down. When risk goes up for LL, increased.  The problem though is that both parties are taking risks and the perceived risk is, unfortunately, often a very subjective thing.  And, of course, cash isn’t the easiest thing to come by these days…

I think to tackle the security issue in a mutually beneficial way LLs and Tenants should start the conversation with a responsible and efficient exploration of respective risk.  Risk in the retail real estate context can be translated into monetary amounts using reasonable assumptions.  For example, if the risk is simply that the LL loses rental income because the tenant vacates and stops paying rent then let’s think about how long properties of such a flavor typically sit vacant when priced properly.  While we are contemplating a price for a future date, parties can use history and market indicators to draw reasonable assumptions.  Often tenants are investing big bucks into the Premises which increases property value and may in fact mitigate any risk the LL will suffer upon a default of Lease.  Conversely, LL’s may find themselves in a situation where their money can only be recovered if a Tenant remains in good standing for a definite period of time and the prospect of finding a replacement is unlikely.  Regardless, these are all things that can be explored collaboratively.  Looking at risk is a great way to get past this very challenging leasing issues and an issue that will remain at the center of retail real estate for the foreseeable future; recession or not.

  1. Interesting post, Jesse. Just wanted to add my thoughts to your post. In my work on behalf of commercial tenants, we try to avoid cash as part of a tenant’s security for its lease obligations. Especially for small businesses, cash is generally at a premium, and it makes little financial sense to park away cash in a LL’s account when it could be better used to build the business. From the LL’s perspective, at least from its long-term perspective, the success of the tenant’s business is the key to full lease performance, and therefore, the more cash the tenant maintains on hand, the more likely the tenant can honor its lease. I have found that a security interest in tenant’s business and sometimes a personal guaranty, if there is no track record for the business, are generally enough security for most commercial leases.

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