When leasing office space in NYC, you should expect to pay a security deposit. There is no standard amount, but the security deposit will equal the monthly rent times X. In other words, it could be 3 months' rent, 6 months' rent, or more, depending on various factors. Consequently, offices with higher rental rates will necessitate that tenants provide a greater sum of money as a deposit.
The security deposit is usually the last business point addressed in the negotiations. The negotiations begin once the tenant has submitted financial information for the landlord's review. The security deposit is negotiable, like the base rent or the landlord's work, but the landlord's flexibility will depend on a number of factors.
People sometimes compare the security deposit for offices to those of apartments. Most of us have rented an apartment and paid a security deposit to the landlord. The standard security deposit for an apartment is only 1-month's rent. Without a frame of reference, one would assume the security deposit for an office would be the same or similar. But in most cases, the security deposit for office space will be greater than 1-month's rent.
Factors Influencing the Security Deposit Amount
In an ideal world, a tenant wouldn't have to pay a security deposit at all. A landlord could just take their word for it: "We'll pay the rent on time and through the end of the term, vacate the property before the lease expiration date, and leave the office space exactly how we found it. "
But things happen. A company could be facing hard times and be unable to carry out the rent obligations in the lease. Or their movers might cancel an appointment, forcing the company to holdover beyond the lease expiration date. When the movers finally arrive, they might bang up the walls and scratch the floors. Sometimes things are beyond our control.
Various factors impact the security deposit. However, the primary factor is the tenant's creditworthiness. Let's look at this in more detail.
Years of Operation: Even before showing an office space to a potential tenant, the landlord's broker will often ask, How long has the company been in business? Suppose a company is new and just starting out. The landlord might only accept the company as a tenant in their building if the company can give the landlord confidence that it can fulfill the lease obligations (i.e., pay the rent).
Financials: The building's representative will ask to review the company's financial information. The potential tenant must submit corporate tax returns or an audited financial statement. (Because the landlord is looking for unequivocal proof of the company's finances, an unaudited balance sheet or profit and loss statement typically will not suffice.) In addition to the tax returns, a landlord might also like to review a few recent bank statements.
References: Commercial landlords are not too concerned with references. In most cases, they don't ask for them. Of course, if you're trying to create a stronger case and your previous landlord is willing to write a reference letter saying that you were an outstanding tenant and always paid your rent on time, by all means, submit it along with the financial package.
A Good-Guy Guarantee Helps Mitigate the Security Deposit
In NYC, it's the norm for a principal of the company to sign a Good-Guy Guarantee. The GGG is a limited personal guarantee that, in a nutshell, says if you can't pay the rent, you'll move out; if you stop paying rent and don't move out, the landlord can take legal action against the signatory of the guarantee. Follow this link for an in-depth explanation of the Good-Guy Guarantee.
With no Good-Guy Guarantee, you should expect the security deposit to be more. Picture this. If your company has solid tax returns, but the principal doesn't sign a Good-Guy Guarantee, the security deposit could be 6 months' rent. If your company is operating at a loss or has weak tax returns and the principal is unwilling to sign a Good-Guy Guanatee, the security deposit could be as much as 8-12 months' rent.
Now that we've listed a few factors that influence the security deposit, we can make an assumption: A company that has been in business for years, submits strong financials, and has a principal who will sign a Good-Guy Guarantee should expect a lower security deposit than a startup with weak or no tax returns and a principal not willing to sign a Good-Guy Guarantee.
Why do you need to pay a security deposit anyway?
There are several reasons for a landlord to hold a security deposit:
The first reason is to warrant against damage to the office. For example, suppose large holes are created in the walls when you remove built-in shelving and wall-mounted television sets. In that case, the landlord might deduct the cost of the repairs from your security deposit.
The second reason for the security deposit is to hedge against expenses associated with a non-paying tenant. If a tenant stops paying rent, the landlord often must evict the tenant. In NYC, this doesn't happen overnight; it can take months. And all the while, the landlord is not collecting rent.
The third reason is to ensure the tenant vacates the office in a timely manner. If the tenant's office lease requires the company to vacate the office by the end of the month, but they haven't removed all their belongings a week or two later, funds might be deducted from the security deposit to compensate the landlord for the extra time.
Any lease violation could impact the tenant's security deposit—but these are the major three.
Flexible Workspace Providers and Shared Sublets
The security deposit requirements for flexible workspace providers and shared sublets are usually less than a traditional office lease. In offices like these, the security deposit is rarely more than a couple of month's rent.
The reason you can expect a lower security deposit in these types of offices is that the tenant doesn’t sign a traditional lease but rather a license agreement. In NYC, if a tenant defaults on a traditional lease but stays in the space (i.e., doesn't move out), the landlord must legally evict the tenant. This takes time and money. And we all know attorneys aren't cheap—hence, the need for a larger security deposit.
However, a license agreement does not offer the same protections to the tenant; if a company stops paying rent in this scenario, they might find they've been locked out of their office space—no eviction necessary. So, less security is required.
Cash vs. Letter of Credit
Most landlords hold the security deposit in their bank account. When you sign the office lease, you write a check to the landlord or wire funds. The landlord holds these funds in an escrow account until the end of the term. If all lease conditions are met, the security deposit is usually returned to the tenant within 30 days.
Some landlords prefer a Letter of Credit (LOC) from the tenant's bank. In this scenario, the landlord isn't responsible for holding the funds and maintaining an escrow account. The tenant's bank guarantees the funds; if an issue arises, the landlord requests the funds from the bank. Some tenants prefer this because they don't have to worry about retrieving the funds from the landlord at the end of the lease term. However, there are costs associated with establishing and maintaining the Letter of Credit. And setting up a Letter of Credit takes time—sometimes a few weeks.
Most landlords have a standard practice in regard to the security deposit: they either require cash or a LOC. But if you have a preference—and some leverage in the negotiations—you might be able to persuade them in one direction or another.
If a tenant is required to post a higher-than-average security deposit at the outset of the lease term, it may be possible to negotiate a burndown. A burndown is simply the return of some of the security deposit to the tenant when certain conditions are met. The conditions always include a history of on-time rental payments over a specific period, usually 1 or 2 years. The landlord might also require the tenant to meet specific income levels.
Here is a typical scenario. If a startup company needs to rent office space, but the company is so new that they do not have tax returns, the landlord might require a 6-month security deposit. The company writes a check to the landlord for 6 times their monthly office rent amount. However, the landlord might agree to reduce the security deposit to 5 months after 1 year and 4 months after 2 years. The burndown amount of the deposit will be applied to the 13th month's rent and the 25th month's rent. The landlord will continue holding the remaining 4 months' security deposit until the end of the lease term.
How much is the security deposit for an office space in NYC?
As we mentioned, it varies depending on the tenant's creditworthiness. But here is a good rule of thumb: If your company rents office space directly from a landlord or subleases an entire suite (not shared space) for a multi-year term, expect to pay a minimum of 3 months' rent.
Landlords who accept 3-month rent as a security deposit for office space will want to see the following:
- A multi-year track record
- "Solid" tax returns
- A Good-Guy Guarantee
A company that fails to provide even one of these 3 conditions should expect to pay more than 3 months of security.
In the New York City office leasing market, understanding the intricacies and norms of commercial security deposits is crucial for prospective tenants. As we've seen, the security deposit can vary significantly based on the tenant's creditworthiness and the presence or absence of a Good-Guy Guarantee. The security deposit directly reflects the risks landlords take on with commercial tenants. While the initial outlay may seem excessive, especially when cash is tight, license agreements or burndowns may offer pathways or lessen the burden over time.
Ultimately, the security deposit is a key component of the lease negotiation process. Make sure you have a knowledgeable real estate broker working on your behalf.