Tenants entering into a commercial lease typically have to provide some form of surety to the landlord to cover the risk of their defaulting on the lease or the landlord having to ‘make good’ the premises, before offering the premises to the market.
The surety amount is usually the equivalent of 3+ months rent and outgoings. In the past, the surety was typically in the form of a bank guarantee.
Financial institutions only issue bank guarantees if they have some form of security i.e., cash in a secured term deposit account or a line of credit/overdraft secured against assets. Either way, working capital is being tied up.
Commercial Lease Bonds replace the need to provide bank guarantees. Commercial Lease Bonds are issued by a leading rated insurance company (the ‘guarantor’) on an ‘unsecured’ basis. Working capital is released to either pay down debt or be put to better use in the business. In addition, Commercial Lease Bonds are financially treated as being ‘off balance sheet’, so company financials are enhanced and the businesses ability to further borrow, is reduced by the amount of the Commercial Lease Bond.
To better understand the complete process, refer ‘What happens if a default occurs?’ below.
A landlord seeks a $50,000 surety (representing 3 months rent and outgoings) for a 5 year lease.
The Commercial Lease Bond Fee, payable in full upfront, is $5,675 (based on this example – variations will occur based on the amount of the bond and the duration), including a non-refundable Application Fee of $550 (includes GST). This averages out to $1,135 per annum. The fee is tax deductible.
Using current cash market rates (April 08), investing the freed up working capital ($50,000.00) could generate a return of approximately $4,000.00 per annum. This level of return ignores the ‘opportunity cost’ of the freed up working capital being used by the business to pay down debt or purchase more inventory and generate higher sales etc. The ‘opportunity cost’ will vary from business to business.
For the Tenant:
For the Landlord:
For both:
Whilst Commercial Lease Bonds have been around for years, insurers have typically focused on the larger corporations. Several more insurers have entered the market more recently, with a focus on the small-medium sized business sector.
The insurers are leading, credit rated Australian or global brands and, as with other financial institutions, are APRA licensed. There’s no reason for a commercial landlord to differentiate between the credit worthiness of bank or insurer issued ‘sureties’.
As Deposit Bonds (used for real estate purchases) required a ‘mind shift’, the same applies to Commercial Lease Bonds. More and more parties involved in commercial leasing are becoming aware of or more comfortable with the concept of Commercial Lease Bonds. We’re seeing more and more commercial lease contract documents stating that ‘insurance bonds’ are an acceptable form of surety.
It’s largely an awareness and education process, however, ultimately it’s at the Landlord’s discretion whether or not to accept a Commercial Lease Bond.
Having said that, it seems rather shortsighted that a landlord will happily place $5M, $10M, $25M Property Insurance (‘short tail risk exposure’) or indeed, $5M, $10M, $25M Public Liability Insurance (‘long tail risk exposure’) with an Australian Prudential Regulatory Authority (APRA) approved and licensed Australian insurer, yet, question the security of the same insurers over a $50K, $100K or $250K insurance bond. APRA is the same government authority that also approves and licenses Australian financial institutions. Insurers and financiers are similarly regulated.
The landlord will claim against the Commercial Lease Bond by calling on the guarantor (the insurer) to release the bond amount to the landlord.
The guarantor (the insurer) will then seek recovery from the applicant or any party acting as guarantee to recover the bond amount paid to the landlord, plus any associated costs.
Commercial Lease Bonds applications will be assessed within 3 business days from the receipt of all necessary documentation.
We’ll advise the insurance broker if the applicant has been successful or otherwise.
If the applicant wishes to proceed we must receive ‘cleared’ funds before issuing the insurance bond.
Yes, if you do not use the bond and return it within 30 days of issue, we will refund the premium paid, less the non-refundable $550 (including GST) administration fee.