April 24, 2017
By: Alex Lassar, Senior Vice President, JLL
A clear trend is developing in the market for office space in the Bay Area: landlords are asking more tenants for higher deposits. Deposits are highest for younger, venture-backed companies without much operating history or clear path to profitability.
Photo credit: Mike Cohen, mjcohen photography, via instagram.com/mjcohenphoto
In some rare cases, deposits have eclipsed the amount of up-front investment a tenant would have otherwise made to build out, refresh, or furnish a space. While avoiding up-front capital to prepare and move into office space is another trend that’s quickly gaining steam these days, the corresponding upward trend in “market” deposits required to securitize a space could, for some tenants yield a zero-sum game – or worse.
First, what is a deposit? Simply, it serves exactly the same purpose as an apartment renter’s security deposit. It’s security for the landlord that you will pay your rent on time, according to the lease terms. Unlike apartments however, this isn’t just a first and last months’ rent situation. What’s different is that an office deposit is intended to mitigate a landlord’s (or sublandlord’s) financial exposure on up-front costs spent to get a tenant into a space. Landlords typically recoup those costs by fully amortizing them over the course of the lease term by including them in the monthly rent payment. Once the cost is fully recouped, the landlord releases the security deposit to the tenant.
Security deposits for office tenants can tie up large sums of working capital, for long periods of time. While some companies with very strong credit may never be asked for a deposit, others – with shaky or not so established credit – may be required to pay six, nine, sometimes twelve or more months rent in advance. That’s what we’re seeing more of in the market today.
Yet, like apartment renters, companies don’t see a return of their deposit until the lease is over. On a five to ten, even a shorter-term three-year lease, that’s a long time for most companies to tie up valuable working capital.
How can tenants mitigate this trend in the current Bay Area market? Here are just two strategies.
Do your homework
Since landlords are raising deposits because they are looking to recoup capital they’ve already invested in their space to attract you, the tenant, in the first place, look for buildings, spaces and fringe situations where landlords haven’t recently put a lot of fresh capital into a space. This is just one of the reasons that sublease space has risen in popularity lately, especially with start ups or companies looking for temporary space until expansion space is finished or a new building becomes available. Nicely appointed, and freshly vacated ‘second generation’ spaces, where someone is coming off of a long-term lease but with very valuable and functional improvements already in place, can operate much in this same way as well.
Burn it down!
No, not the space, the deposit. Some landlords will entertain performance clauses (so called “burn-downs”) when negotiating deposits. So, if a tenant performs (pays rent in full, on time and stays out of default) in the first part of their lease, the landlord might agree to return a portion, sometimes significant, of the deposit. Some landlords may even add a financial test as a stipulation to a tenant receiving a burn-down at the stipulated time. Since these mechanics are beneficial to a tenant, but can get complicated, a good tenant rep broker will know how to not only mitigate the up-front deposit required, but also negotiate a faster and more likely return of the deposit.
As always, every deal is slightly different and other strategies may also be beneficial to the process. Talk to your real estate advisor about the options available in the market, the prevailing trends and gather as much local market and landlord intelligence as you can. Doing so may well allow you to retain precious working capital for the business, rather than typing it up in the real estate unnecessarily.
I have helped companies find, negotiate, re-negotiate, and otherwise optimize their office space and office leases for over 13 years. My primary focus is on the San Francisco market where I typically oversees 2,500 to 500,000 sq foot transactions, but I’ve also negotiated spaces for national clients—from one-off transactions to 1M+ square foot portfolios to everything in between. I believe that no company is too small to benefit from JLL’s global platform.
Contact me directly by phone at +1 (415) 395-7218 or by email at firstname.lastname@example.org.