What is a Security Deposit Burn Down in  a Commercial Lease?

In commercial real estate leasing, security deposits serve as a critical risk mitigation tool for landlords. Unlike residential leases, where security deposits are often limited by law, commercial landlords have significant discretion in setting the amount and conditions under which they are held. Given the substantial financial commitments landlords make when securing a tenant—such as leasing commissions, build-out costs, tenant improvement allowances, legal fees, and rent concessions—security deposits provide a safeguard against potential tenant defaults. However, as a tenant successfully operates in a space and demonstrates financial stability, landlords may agree to reduce the security deposit over time through a negotiated “burn down” provision.

Understanding Security Deposits in Commercial Leases

A security deposit in a commercial lease serves as financial protection for the landlord in case of tenant default or lease violations. The amount required varies based on several factors, including:

• The tenant’s credit profile and financial stability.
• The type of commercial space (e.g., office, retail, industrial).
• tenant incentives provided by the landlord, such as rent concessions or improvement allowances.
• Other forms of credit support provided by the tenant such as a guaranty from the tenant’s owner or a parent entity.

What is a Security Deposit Burn Down?

A security deposit reduction or “burn down” provision allows tenants to reduce the deposit amount over time, provided they meet specific conditions. This arrangement offers a compromise: landlords maintain financial protection in the early lease years, while tenants benefit from reduced capital constraints as they establish their business in the space.

Burn down provisions are generally structured in one of two ways:

1. Time-Based Reductions – The security deposit decreases at predefined intervals, often after the second or fifth lease year, as long as the tenant remains in good standing.
2. Performance-Based Reductions – The deposit reduction is tied to the tenant achieving specific financial milestones, such as revenue targets or maintaining certain profitability levels.

In most cases, burn downs occur in one or more stages and are conditioned on the tenant not being in default under the lease beyond any applicable notice and cure period. If an event of default occurs, even if the landlord allows the tenant to cure the issue and continue the lease, the burn down right may be forfeited.

Key Considerations in Negotiating Burn Down Provisions

1. Landlord Perspective: Risk Management

From a landlord’s standpoint, a security deposit provides a financial safety net against tenant nonperformance. Because landlords typically invest heavily in acquiring tenants—incurring costs such as tenant improvement allowances, legal fees, and broker commissions—they aim to ensure sufficient protection against losses.

Landlords are often more willing to agree to a burn down provision when:

• The tenant has a strong financial history and a well-established business.
• The lease term is long enough to justify the initial concessions.
• The tenant’s industry is stable and presents minimal default risk.

Even when agreeing to a burn down provision, landlords often impose conditions such as:

• No uncured monetary or non-monetary defaults.
• Minimum financial thresholds (e.g., EBITDA or net worth benchmarks).
• Continuous operation in the premises without assignment or subletting.

2. Tenant Perspective: Cash Flow and Flexibility

Security deposits, especially large ones, can tie up capital that tenants would rather allocate to business growth, inventory, or operational expenses. Negotiating a burn down provision allows tenants to reduce the long-term financial burden of leasing while maintaining compliance with their obligations.

Tenants should consider:

• Seeking a defined timeline for reductions to ensure predictable cost savings.
• Requesting a mechanism for automatically reducing a security deposit without needing landlord approval.
• Ensuring that any conditions tied to burn down are reasonable and achievable.

3. Structuring the Burn Down in the LOI Stage

Burn down provisions should be discussed early in lease negotiations, ideally at the Letter of Intent (LOI) or term sheet stage. This ensures that both parties are aligned on expectations before formal lease drafting begins. The LOI should specify:

• The initial deposit amount.
• The timing and amount of each reduction.
• Any conditions that must be met.
• Whether reductions occur automatically or require landlord approval.

Conclusion

Security deposit burn down provisions offer a valuable potential compromise between landlords’ need for financial security and tenants’ desire for cash flow flexibility. When negotiating a commercial lease, tenants should advocate for a structured and well-defined burn down mechanism to ease long-term financial constraints. Meanwhile, landlords should weigh the benefits of reducing financial burdens on tenants against the risks of potential default.

As with any lease negotiation, both parties should seek legal counsel to ensure the lease language is clear, enforceable, and aligned with their respective interests. Thoughtfully structured security deposit provisions can help foster a strong landlord-tenant relationship while protecting both parties’ financial positions throughout the lease term.