“Burn Down” Provisions

burndown

Burn down provisions do not refer to righteous retribution over the loss of one’s favorite red stapler but rather refer to a strategy for lowering a tenant’s security deposit over the term of the lease.

For the majority of low risk tenants, commercial landlords will require the minimum security deposit of one month’s rent. This monthly number is generally based on the amount payable in the first year of the lease term, but some landlords may require that it be the rent payable in the last year of the lease term. In either case, the security deposit is not subject to reduction.

For tenants that present an element of risk beyond a landlord’s acceptable risk profile, an increased security deposit may be required. This generally takes the form of multiple months’ rent but can also be tied to other economic concessions such as tenant improvement allowances or market conditions such as estimated lease up time. Whatever the reason, an increased security deposit can present tenants with significant financial hardships which may make the deal untenable.

Burn down provisions provide a way for tenants to get back some of that increased security deposit over the term of the lease. Typically they are structured such that, if the tenant is not in default (beyond applicable notice and cure periods, an important distinction), the landlord will return a portion of the security deposit after a certain period of time. This amount can be all at once or staggered over time until the security deposit is reduced to one month’s rent.

For example, a tenant desires to enter into a 5-year lease from a landlord who, after reviewing the tenant’s financials, will require a 3-month security deposit to mitigate their risk. The tenant, not wanting to have that cash tied up for the entire term of the lease, can try to negotiate a burn down provision so that on the first anniversary of the lease commencement date the landlord will return a portion of the security deposit in the amount of 2 months’ rent. The landlord may push back and modify the terms so that only one month’s rent is returned on the 1st anniversary of the lease commencement date and the additional month on the 2nd anniversary of the lease commencement date.

Due to the time value of money, the tenant will want as much of the security deposit refunded as quickly as possible while the landlord will want to hold onto as much of the money as possible for the longest period of time. As always it’s recommended to seek the advice of an experienced commercial broker who understands both the tenant’s and landlord’s needs and can thus structure terms that satisfy both.

For more information or if you have any questions, please contact Ryan Rauner, CCIM at 703-943-7079 and Ryan@RealMarkets.com

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s