Why is it important for a landlord to have security when letting a commercial property?
A landlord’s objective when letting commercial property is to secure an income stream. The tenant’s ability to pay the rent is fundamental to this.
It is important for landlords to carry out thorough background checks on prospective tenants before granting the lease. These will include obtaining references, at least one financial, insolvency checks and a search of the Companies House register for limited companies. Where there are doubts about a tenant’s financial standing, landlords should take security from the tenant. The two most common forms of security are a rent deposit or a personal guarantee.
Rent Deposit
A rent deposit is a sum of money paid by the tenant and held by the landlord until the lease expires. Depending on the nature and length of the letting, and financial standing of the tenant, a rent deposit can be anything from one months to twelve months’ rent, calculated as a multiple of the monthly rent.
The deposit remains the property of the tenant. The landlord will hold the deposit in a separate, interest-bearing account, with the interest payable to the tenant on an annual basis.
If the tenant fails to pay the rent or there is another breach of the lease by the tenant, the landlord can deduct money from the deposit.
If the landlord withdraws monies from the deposit, then the tenant is required to top up the deposit to the original amount.
When the lease ends the landlord must return the rent deposit to the tenant together with any interest accrued, subject to any agreed deductions.
The advantage of a rent deposit is that the landlord has control of the money. The disadvantage for the tenant is that the cash will be tied up for the term of the lease.
The terms on which a rent deposit is paid is documented in a rent deposit deed to avoid disputes between the landlord and a tenant.
Personal Guarantee
An alternative to a rent deposit is a personal guarantee. A personal guarantee is a promise by a third party to ensure that the tenant complies with its obligations under the lease. There is also an obligation to indemnify the landlord for loss suffered if there is a breach of the lease by the tenant.
If a tenant is a limited company a director of that company may be willing to act as a personal guarantor for the company. For the landlord this is important if the company is newly incorporated.
A guarantee may be an attractive option for a tenant as it does not require any funds to be deposited with the landlord. For a landlord it has the advantage that the guarantor can be required to step into the shoes of the tenant and will be liable for compliance with all lease covenants if the tenant defaults.
The landlord must ensure that the guarantee is uncapped and not limited in time.
Where the prospective tenant is seen to be a considerable risk, then a landlord can require a rent deposit and personal guarantee.
The amount of security provided will vary depending on the bargaining powers of both parties. A landlord eager to let a property quickly may not be able to hold a tenant to ransom with unreasonable demands of security.
Guarantees and deposits offer an effective form of security with advantages for both landlords and tenants. It is essential that the security is properly documented to ensure that the guarantor or deposit is not unintentionally released while the tenant’s obligations are ongoing.
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