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Commercial real estate leasing and security deposits: What you should know

It’s common practice in commercial real estate for landlords to collect a security deposit when a tenant leases a property.  The purpose of security deposits is to assure that a tenant pays rent on time and keeps the property in good condition.  There are often limitations on how much a security deposit can be and how a security deposit can be used by a landlord, which vary by location.   The exact provisions should be clearly defined in the lease agreement.   However, the amount is usually between one and two months rent, which is returned to the tenant within thirty to sixty days following the termination of the lease, less any deductions for damage to the property or unpaid balances.

As stated above, the sole purpose of a security deposit is to provide a landlord with some collateral in case the tenant damages the landlord’s property or does not fulfill their obligations under the lease.   In most instances tenants abide by the terms of their lease and the security deposit is returned after they move out.   However, there are times when tenants fail to pay rent, damage the property, defer maintenance, or simply leave the premises a mess.   In these instances the landlord will incur costs to get the property back to its original condition.   Most lease agreements state that it is the tenant’s responsibility to leave the property in the same condition as when they moved in, less normal wear and tear.  Therefore, the security deposit is in place to make sure there are funds available to restore the property if the tenant does not.

There is some subjectivity on how a security deposit can be applied, where it is held, and how the landlord can use the funds, which is why the lease is very important.  The lease should document:

  • the type of account in which the money is held (interest bearing or non interest bearing)

  • timing as to when the deposit is returned (how long after lease termination)

  • the type of expenses the security deposit can be used for (damage to the property, trash removal, burnt out lights, unpaid bills, etc.)

The tenant should request, and the landlord should provide, a detailed account statement which demonstrates exactly how the security deposit is applied, including an itemized list of all the expenses. This will avoid any confusion as to how the money was spent.

The concept of requiring a deposit to use an item owned by another is nothing new.   Many rental businesses use this concept everyday, and commercial real estate is no exception.  The only real difference is that with a commercial real estate transaction there is often some flexibility in the terms of the security deposit. That is why it is very important to document carefully all aspects related to the security deposit within the lease agreement.

Gregory C. Cassel, Commercial Asset Manager for High Associates