The deposit is negotiated in months of rent; the exposure it is meant to cover is almost never written down beside it.
Size a commercial security deposit against what a tenant default would actually cost the landlord, not against a habit of three months' rent. On an illustrative 15,000 sq ft office let at $540,000 a year, a default costs $1,381,000, or 30.7 months of rent, once arrears, the void, empty running costs and the cost of re-letting are counted. A three-month deposit covers 9.8 per cent of that. Covering only the cash lost before a new tenant signs, $745,000, takes 16.6 months.
Worked in full in How to Read a Commercial Lease by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The deposit clause is usually negotiated as a number of months, with little reference to the rest of the lease. Reading it properly means setting it beside the exposure the lease creates: how long it takes to recover the space, what the space costs to hold empty, and what the next tenant will need to sign.
| Input | Value |
|---|---|
| Area | 15,000 sq ft |
| Base rent | $36.00 per sq ft ($45,000 a month) |
| Operating cost recoveries | $12.00 per sq ft ($15,000 a month) |
| Months of arrears before the landlord regains possession | 3 |
| Legal and possession costs | $25,000 |
| Void before a new tenant signs | 9 months |
| Free rent to the new tenant | 4 months |
| Leasing commission | 15% of a year's rent |
| Fit-out contribution to the new tenant | $25.00 per sq ft |
| Item | Amount, $ | Months of rent |
|---|---|---|
| Unpaid rent before possession | 135,000 | 3.0 |
| Unpaid operating cost recoveries before possession | 45,000 | 1.0 |
| Legal and possession costs | 25,000 | 0.6 |
| Rent lost while vacant | 405,000 | 9.0 |
| Operating costs while vacant | 135,000 | 3.0 |
| Free rent to the new tenant | 180,000 | 4.0 |
| Leasing commission | 81,000 | 1.8 |
| Fit-out contribution to the new tenant | 375,000 | 8.3 |
| Total exposure | 1,381,000 | 30.7 |
Exposure in months = (arrears + costs + void × (rent + opex) + re-letting costs) ÷ monthly rent
$1,381,000 ÷ $45,000 = 30.7 months. The first five lines, $745,000 or 16.6 months, are cash lost before a new tenant signs; the last three are the price of getting a new tenant to sign.
In Excel, with the eight items in B2:B9 and the monthly rent in B11: =SUM(B2:B9)/B11
The operating cost lines are the ones usually forgotten. On a net lease the tenant pays the building's running costs; once it stops, the landlord pays them, $15,000 a month here, a third as much again as the lost rent. The re-letting lines are larger than many landlords expect because the market sets them, not the defaulting tenant's lease: the next tenant asks for its own fit-out and free period regardless of how the space was left.
| Deposit, months | Amount, $ | Share of total exposure | Share of cash loss before re-letting |
|---|---|---|---|
| 3 | 135,000 | 9.8% | 18.1% |
| 6 | 270,000 | 19.6% | 36.2% |
| 12 | 540,000 | 39.1% | 72.5% |
Even a year's rent leaves the landlord bearing most of the loss. That is not an argument for demanding 30 months: no tenant with a credit profile worth signing would agree, and the landlord keeps a damages claim for the rest. It is an argument for choosing the deposit knowingly, against the cash loss before re-letting, and for weighting it by the tenant's credit: a strong covenant may justify three months, a start-up taking a large fit-out may justify twelve or a guarantee on top.
The damages claim is weaker than it looks. In a US bankruptcy, section 502(b)(6) of the Bankruptcy Code broadly caps the landlord's claim for future rent at the greater of one year's rent or 15 per cent of the remaining term's rent, not exceeding three years. With 8 years left, 15 per cent of $4,320,000 is $648,000, 1.2 years of rent, and it ranks as an unsecured claim. The deposit or letter of credit is often the only part of the recovery the landlord can count on.
| Void, months | Total exposure, $ | Months of rent | Covered by a 6-month deposit |
|---|---|---|---|
| 6 | 1,201,000 | 26.7 | 22.5% |
| 9 | 1,381,000 | 30.7 | 19.6% |
| 12 | 1,561,000 | 34.7 | 17.3% |
| 18 | 1,921,000 | 42.7 | 14.1% |
Each extra month of void adds $60,000, rent plus running costs. A deposit sized in a tight market, when space re-lets in six months, covers 22.5 per cent of the loss; the same deposit covers 14.1 per cent if the market turns and the void runs to eighteen. Defaults cluster in weak markets, so the longer voids are the relevant ones.
Measuring the deposit in months of rent and the exposure in nothing at all. "Three months" sounds like three months of protection, but on this lease the first three months of the default are already arrears before the landlord has the keys back. A second error is letting the deposit burn down on a fixed schedule unrelated to the exposure: the fit-out and void costs do not fall as the lease ages, so a deposit that halves after three years leaves the later default as expensive as the early one. Tie any reduction to the tenant's credit, and check the exposure again at each step.
Possession timetables, deposit rules and insolvency caps vary by jurisdiction and lease. The figures here are illustrative and not legal advice.
The free working documents and workbook on the companion page for this book include a security schedule set beside the exposure. The cost of the void alone is worked in how much a lease expiry costs in lost rent and fees.
Commonly between three and twelve months, depending on the tenant's credit and the landlord's capital at risk. Against the illustrative exposure of $1,381,000, three months ($135,000) covers 9.8 per cent, six months 19.6 per cent and twelve months 39.1 per cent, which is why weaker tenants are often asked for a guarantee as well.
For the landlord, usually yes, if it is issued by a strong bank and can be drawn on demand: it survives the tenant's insolvency outside the estate in most cases, while cash may be argued over. For the tenant it costs a bank fee instead of tying up cash. Either way it should be sized against the exposure, here $745,000 of cash loss before re-letting.
No. Section 502(b)(6) of the Bankruptcy Code broadly caps the claim for future rent at the greater of one year's rent or 15 per cent of the remaining term's rent, up to three years. With 8 years and $4,320,000 left, the cap is $648,000, and it is unsecured, which makes the deposit the most reliable part of the recovery.
This article is one calculation from How to Read a Commercial Lease. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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