An Innovative Approach to Commercial Real Estate Leasing
Like residential leases, commercial landlords ask the majority of their tenants for security deposits. The difference, however, is that there aren't any laws that govern how much a commercial landlord can ask for. Each landlord assesses risk differently, and the amount of security deposit required is determined by a tenant’s financial strength and total monthly rent. Significant build outs, large concession packages and other factors also impact the amount of security deposit required, since landlords pay for those expenses upfront and bake the costs back into the tenant’s rent over the length of the lease. There is often a gap between what a tenant is willing to pay and what the landlord needs in order to feel adequately protected, causing lease securitization to be a major point of contention during negotiations. Security deposits restrict large amounts of a company’s working capital for the length of the lease, preventing them from being able to deploy it into their business and enjoy a return on that money.
Up until the 90’s, cash was the sole form of commercial security deposits. The market shifted towards letters of credit after the dot.com bubble and economic recession, when landlords learned that once a tenant files for bankruptcy, they may take no further action to collect past-due rent or offset the security deposit. Landlords need permission from the court in order to access the funds and in some cases, may even be required to return the cash altogether. Letters of credit, however, benefit from the independence principle, providing landlords with bankruptcy protection because it’s a separate legal obligation with the bank.. As the economy recovered, the letter of credit helped ensure companies met their rental obligations and gave landlords a greater sense of security. Unfortunately though, this innovation just made security deposits even more costly and cumbersome for tenants. So much so, that a large number of landlords still accept cash and if anything, just ask for more.
Fast forward 30 years and letters of credit remain the first and only innovation when it comes to commercial security deposits. The rest of the commercial real estate landscape, however, has been rapidly changing to meet the new set of tenant demands -- a lot of which directly impact the size of their security deposit. Opportunity cost of cash is high and existing lease securitization solutions are too expensive.
For a typical commercial lease, a bank charges about 2% annually for a letter of credit. The actual costs to the tenant are much higher though, because most companies are required to secure an LC with an equivalent amount of capital, meaning that cash is restricted for the length of the lease. If the tenant was able to deploy that capital into their business instead, they could enjoy a return on that money.
Opportunity cost of cash is high, up to 25%, depending on a company’s cost of capital. Letters of credit can cost up to 15%, depending on the amount of collateral and the 1-2% it costs to put in place.
When LCs aren’t secured by cash, they’re usually structured as carve-outs of large revolving credit facilities. For example, consider a company with a $10M revolving line of credit secured by accounts receivable. If a $1M letter of credit is needed, the business would use 10% of its available credit just to secure their lease, limiting their operational flexibility.
To obtain a letter of credit, a tenant must have an established banking relationship. Adding the stress of the additional legwork to find the right bank relationship, go through the proper process of getting approved, which can take several months, and have the capital to secure the financing, can surpass the timeline the tenant had hoped to have for their landlord. For tenants with existing banking relationships, this process can still take weeks to months, since banks view letters of credit as a relationship instrument rather than an income-generating product.
TheGuarantors, a fintech startup that focuses on finding innovative ways to solve risk in leasing, estimates that there are over $51B dollars tied up in commercial security deposits nationwide. They've developed a new product, Securiti, that can change the way tenants and landlords look at securitizing leases, by offering an insurance alternative that’s equitable for both the tenant and landlord. This product taps into a market that has practically been untouched in decades.
Securiti replaces a cash deposit or letter of credit with a surety bond designed specifically for commercial leases. Securiti is priced to risk, so it only costs tenants a small annual premium (2-9% of the security deposit amount) that is significantly cheaper than traditional alternatives. With Securiti, tenants are able to unlock working capital and increase liquidity on their balance sheets while providing coverage to landlords that’s no-nonsense and reliable -- just like cash or an LC. All Securiti bonds are payable on demand, bankruptcy remote and issued by investment grade insurance carriers, like Chubb.
Securiti is a tool that can ultimately help companies grow - it allows tenants to keep their capital and maximize their operational flexibility, something that every company can benefit from. There is no collateral required and no impact on credit capacity so the business can borrow as needed.
While letters of credit, as earlier expressed, can often take between one to two months to acquire with minimal interaction with the lending bank, Securiti is generally offered within one week after financial approval of the tenant. It offers a more seamless process, creating a new market in the way tenants secure and finance their leases. Another ‘service’ that Securiti offers is flexibility, a selling point that is not offered with a letter of credit. Securiti bonds can be tailored to meet a specific company’s and landlord’s needs. For example, Securiti bonds can be issued for the full security deposit, a partial amount or for the amount of the landlord’s upfront investment, mimicking any burn down negotiated in the lease.
Industries of all scopes are always interested in increasing working capital and gaining liquidity on their balance sheets while minimizing their risk. Having to put down a hefty security deposit and pay fees for a letter of credit for a new or existing lease often raises tensions, especially in as uncertain times as these. Securiti is an innovative approach to offering an economic solution and flexibility to commercial leases.