What should I expect to pay for a security deposit?
The 411 on Security Deposits
We get questions a lot from clients and tenants asking us about security deposits. Clients want to know what they should expect to pay, why they have to pay a security deposit for a commercial lease in the first place, and how exactly is that amount determined? Yes, security deposits can come off as arbitrary to the tenant. Although there isn’t always an appearance of a consistent formula, there are landlord expectations and things you can expect that we will answer to inform you better as you sign your lease.
First, let’s get the basics out of the way:
What is a security deposit? A security deposit is a letter of credit from your bank that’s usually cash securitized (meaning your bank actually withdraws cash from your account and holds it in escrow in the amount of the security deposit). The amount of security deposit can range (see below for more specifics) but is typically a specified number of months of the first year’s rent (i.e. if your year 1 rent is $100,000 and the security deposit your broker negotiates is 6 months, you will post a cash securitized letter of credit for $50,000 with your bank). You can read more here.
Okay, I sorta get it now but I still have questions:
Why do I have to pay a security deposit for an NYC commercial lease? The idea is that because landlords have a notoriously difficult time evicting non-paying tenants in NYC, the security deposit allows your landlord to hedge against the risk that you will stop paying rent and continue occupying the space while they spend months evicting you in court. Your letter of credit gives your landlord permission to draw down (meaning take the cash) from your security deposit in the event you do not pay rent and are in default of your lease (this will be spelled out in your lease).
How is the amount of security deposit decided? If you’ve done a commercial real estate deal before, you know that it typically takes your broker multiple rounds of negotiation to finalize the terms of a lease (known as a “term sheet”, or an outline of the economic and basic non-economic terms of a lease that will become part of the longer, more formal lease document negotiated by lawyers). During these rounds, you’ll often see security deposit as “TBD based on financials”. They are typically the last economic term negotiated before the term sheet is finalized, and are based on a review of your financials by your prospective landlord. The definition of what “financials” means can vary by the landlord, but they typically ask for the last 3 years of tax returns or audited financials – there is often a conversation or two between the landlord and tenant to answer questions on the financials that can help give color to the numbers. For startups, providing investor decks can also help your landlord get comfortable with your credit as a tenant and get excited about your story. In either case, a landlord (and your broker) will always sign an NDA if needed.
Once financials are provided and reviewed, the landlord’s broker will provide your broker an ask on security deposit – this is typically a specific number of months of the first year’s rent. Your broker (with you in the communication) will then negotiate this ask, and the specific number of months will be finalized (example: if your year 1 rent is $100,000 and the security deposit your broker negotiates is 6 months, you will post a cash securitized letter of credit for $50,000 with your bank). You will set up the letter of credit through your bank and send this to your landlord for approval before the lease is signed.
Can my landlord access the funds in security deposit any time and for any reason Short answer: No. Your landlord can only draw down on these funds in the event that you stop paying rent and are in default of the lease – again, this will be defined in your lease. Once you’re in default of the lease, your landlord does have the right to draw down on security.
During COVID, many landlords allowed their tenants to use their security deposits in lieu of rent payments if and when they weren’t able to pay rent due to the pandemic, with the understanding that the tenant will repay the deposit in a specified amount of time.