Understanding Commercial Lease Security Deposits in Texas

So you’ve found the perfect commercial property to rent for your business. Now it’s time to negotiate the commercial lease terms and conditions. One of those important terms necessary to negotiate upfront is the commercial lease security deposit as this must be paid upfront when a tenant signs the lease. 

This financial safeguard serves to protect both parties, ensuring that the leased property is maintained in good condition and any potential damages are rectified. In this article, we will delve into the intricacies of commercial lease security deposits, exploring how they work, their purposes, and the factors that determine their amounts.

What is The Security Deposit in a Commercial Lease? 

The security deposit is a one time payment made by tenant concurrent with the execution of a commercial lease to a landlord or property owner. It’s used to cover any potential damage caused by the tenant, unpaid rent, or breach of lease terms. The payment is usually made in the form of a cashier’s check, money order, or bank transfer.

Why Do Commercial Landlords Require a Security Deposit?

When leasing commercial space landlords incur a lot of upfront costs in the form of tenant improvements and broker commissions, which typically take months for them to recover before being profitable on a deal . Because they take on so much upfront risk they have to collect some sort of collateral in case the tenant defaults. 

For example:

Let’s say a tenant wants to lease a 3,000 sf office space in Austin Tx, but before they move in they would like to have it built out to their specifications. The landlord has agreed to provide an allowance of $100,000 (Approx $33 PSF). They are about to sign a 5 year lease at a gross rate of $30 Sf. Total broker commissions will be $27,000. The total upfront cost for the landlord on this deal will be $127,000. The tenants monthly rent payments will be $7,500 / mo.

As you can see the in example above it will take the landlord 17 months to recoup their initial investment of $127,000 ($7,500 x 17). If a default occurs landlords can use the deposit to cover them. In most cases landlords only charge a security deposit equal to 1-2 months rent so they are only recouping a portion of their initial investment. 

How Much is the Deposit on a Commercial Property?

The amount of security deposit is typically negotiated between the landlord and the tenant before the lease is signed. In many cases it will typically be equal to 1-2 months of rent unless the tenant has week financials or tenant improvement costs are high. Several factors influence how much a landlord can charge. 

1. Tenant’s Financial Standing: Landlords assess the creditworthiness of tenants by reviewing their financial history, credit scores, and business stability. A tenant with a strong credit profile may be able to negotiate a lower amount.
2. Type of Business: The nature of the tenant’s business can have an impact. Certain businesses that involve higher risks or potential damage may require a larger deposit.
3. Cost of Tenant Improvements: If the property being leased requires significant repairs or renovations, the landlord may request a higher deposit
4. Rental Market: The amount may vary depending on the current rental market conditions in the specific location. In competitive markets with high demand, landlords may require larger deposits to secure a lease.

It’s important to note that this can be negotiated, however newer businesses and startups will typically be required to pay large security deposit compared to existing, established businesses with a strong credit history. Also the higher the cost of tenant improvements the higher the security deposit. 

What Financials Will a Tenant Need to Show When Determining Deposit Amount?

If the tenant is a company that has been in business for a while they must show 2-3 years of profit & loss statements and balance sheets. If it’s a newer business or startup landlords will want to see one or more of the following: 2-3 years of tax returns, bank statements, preapproval bank loan letters, etc.

What Happens If the Tenant Defaults on the Lease Contract?

In the event that the Tenant violates any terms of the contract, the Landlord has the right to utilize, apply, or keep the commercial security Deposit, either in whole or in part, to cover any outstanding Rent or any other amount in default. The Security Deposit may also be used to rectify the Tenant’s breach of this agreement or to reimburse the Landlord for any losses or damages resulting from the Tenant’s violation.

How Do Commercial Lease Deposits Work in Texas?

Commercial lease security deposits work similarly to residential, but there may be some variations depending on state and local laws as well as the terms of the lease agreement.  Texas for example has different requirements than other states:

• Limit on the Amount – In Texas there is no cap on the amount a commercial landlord can require. It depends on factors such as the type of commercial property, location, the tenant’s financial strength and creditworthiness, tenant improvement costs, and commissions.
• Return – Has to be returned within 60 days after the date of premises surrender and notice of tenant’s forwarding address.
• Interest – Texas does not require landlords to pay tenants interest or hold the funds in interest bearing accounts. Rules vary in other jurisdictions so it’s important to check the specific regulations in your area.
• Deductions and Disputes – Landlords may not keep any portion of the deposit to cover normal wear & tear. If the tenant causes any damage to the property or fails to pay rent, the landlord may deduct the necessary expenses as long as a written itemized list of deductions is provided along with any remaining balance. If a tenant owes rent when surrendering possession landlord is not required to give an itemized list of deductions.
• Holding the Money – Landlords are not required to keep the deposit in a separate account. Comingling of funds is not prohibited in Texas.
• Skipping last months rent – Tenants are not allowed to skip the last months rent thinking the landlord can just keep the security deposit. This is considered an act of “bad faith” and tenants can be sued for 3 times the rent for this.

When Must a Landlord Return the Security Deposit Amount?

The deposit is typically refundable at the end of the lease term, provided the tenant has fulfilled all obligations and there are no outstanding issues. In most cases it’s returned within 30 days. According to Title 8 Section 93.005 of the Texas Property Code landlords are required to refund the deposit to the tenant no later than the 60th days following the expiration of the lease and surrender the premises, and upon Landlord’s receipt of Tenant’s forwarding address. 

Purposes of Security Deposits in Commercial Real Estate Leases:

The purpose of security deposits in commercial real estate leases is to provide financial safety net for landlords in case of tenant default or property damage. 

1. Ensuring Tenant Responsibility: Security deposits incentivize tenants to keep the property in good condition and fulfill their lease obligations, knowing that they could lose their deposit if they don’t.
2. Damage Repair: They cover any damages to the property that go beyond normal wear and tear. This includes repairs due to neglect, intentional damage, or alterations made by the tenant without proper authorization.
3. Unpaid Rent or Expenses: If a tenant is unable to pay rent or fails to cover certain expenses as stipulated in the lease agreement, the security deposit is used to offset these losses.

Negotiating the Security Deposit in the Lease Agreement

Always try to negotiate the security deposit during the commercial real estate leasing process. When doing so consider a few key factors. 

• Understand the market conditions in the area – If the rental market is competitive, landlords may be less willing to negotiate. However, in a slower market, landlords may be more open to negotiation. 
• Get your financials in order – If you have a good rental history, strong financials, and good credit, this can give you leverage to negotiate a lower security deposit.
• Be prepared to offer alternatives or concessions – For example, you could offer to pay a higher monthly rent in exchange for a lower security deposit.
• Research the landlord’s policies and past experiences – Knowing if they have made exceptions to security deposits in the past can help guide your negotiation strategy. 

Deposit Clause in the Lease

The security deposit is a payment that will routinely be required anytime a business is signing a commercial lease. It provides financial security to landlords and encourages tenants to maintain the leased property in good condition. By understanding how security deposits work, their intended purposes, and the factors influencing their amounts tenants should be better prepared to rent their commercial space.

When entering into a commercial lease, it’s essential to thoroughly review the terms related to security deposits and ensure that both parties are on the same page to avoid potential conflicts in the future.

Remember, this is a general overview, not everything you need to know, and the specific details of commercial lease security deposits may vary depending on the terms of the lease agreement and local laws. It’s always recommended to review the deposit clause in the lease and seek legal advice if needed.

If you have any questions about your commercial lease contract or need helping finding Austin commercial space for rent please feel free to contact us anytime. Having an experience tenant representation broker on your side can help you find the best spaces, mitigate your risks, and get the best deal possible.