What are Rental Guarantee Bonds?
If a commercial tenant defaults on their monthly rental obligations, the landlord is left with a shortfall in rental income required to service outgoings, most importantly including loan servicing.
Yes, the landlord may hold a bank guarantee or Commercial Lease Bond that covers an initial 3 months or so of rent and outgoings (although this amount could be depleted or exhausted by having to use the funds to ‘make good’ the premises), but what about the longer term?
What if the landlord can’t find a replacement tenant? What if the market conditions force the landlord to accept a replacement tenant at a lower monthly rent?
Rental Guarantee Bonds cover any shortfall in monthly rent:
- After exhaustion of the initial default surety i.e., bank guarantee or Commercial Lease Bond;
- Until a replacement tenant has been found;
- Any shortfall in the monthly rent under the new lease agreement and the previous lease agreement;
The indemnity period can be up to 24 months; however, the Rental Guarantee Bond will stop paying the shortfall at the expiry date of the defaulting commercial lease agreement, not the new commercial lease agreement.
Are additional expenses such as rates and insurance covered?
Yes, providing they are identified as payable under the Commercial Lease Agreement and declared in the application. Generally, whatever outgoings are payable by the tenant/lessee under the Commercial Lease Agreement are covered under the Rental Guarantee Bond.
Does the term of the lease matter?
Rental Guarantee Bonds can be issued for commercial leases of up to 5 years.
Do rental increases during the period change the amount of the Rental Guarantee Bond?
Typically, the Commercial Lease Agreement is subject to an annual indexed adjustment. The Rental Guarantee Bond is issued for the initial amount of rental and any covered outgoings. The bond amount will be indexed by the same annual indexed adjustment.
An example of how the Rental Guarantee Bond delivers?
- Commercial lease is for a period of 3 years (36 months) at $100,000 rent and outgoings per month. We’ll assume a 3% annual indexed adjustment.
- Under the commercial lease agreement the landlord holds a bank guarantee or Commercial Lease Bond for $300,000, being the equivalent of 3 months rent and outgoings.
- At month 18, into the 36 month commercial lease, the tenant defaults.
- The landlord claims under the bank guarantee or Commercial Lease Bond and receives the equivalent of 3 months rent.
- The landlord sets about to find a replacement tenant.
- At the end of the initial 3 months vacancy period, the landlord still hasn’t found a replacement tenant. The landlord can start to claim $103,000 per month (year 1 $100,000 + 3% annual indexed adjustment) under the Rental Guarantee Bond.
- 6 months later, the landlord secures a replacement tenant, however, current market conditions will only support a monthly rent of $85,000. The landlord can continue to claims the $21,090 monthly shortfall (being $100,000 + year 2 annual indexed adjustment = $106,090) for a further 12 months up to the end of the original lease period of 36 months.
Under the above example, the landlord would have claimed:
- After the initial 3 months funding under the bank guarantee or Commercial Lease Bond, 3 months x $103,000 = $309,000.
- At month 24, a replacement tenant, however a $21,090 per month shortfall. Original lease to expire at 36 months, so 12 x $21,090 = $253,080.
- If the landlord was forced to use all or part of the initial $100, 000 under the bank guarantee or Commercial Lease Bond to make good the premises, the Rental Guarantee Bond would have been triggered earlier, resulting in an additional amount up to $300,000.
What are the benefits?
For the landlord:
- Any monthly shortfalls, incurred during the indemnity period, are paid
- By having 100% monthly rental guaranteed, the landlord can fund committed outgoings, particularly loan repayments
- The landlord doesn’t have to make a judgment about the financial status of the tenant
- The guarantor (the insurer) becomes accountable to pursue the defaulting tenant or the party(ies) providing the guarantees
- The landlord is a better quality of risk to financiers as monthly finance obligations can be maintained, even when premises are untenanted
- The capital value of the premises increases as rental income is guaranteed
For the tenant:
- In the event of long term leases being assigned, personal guarantees often stay in place with the assignment, with potentially high exposure
- In the event of future shareholder or partner changes, avoids any difficulties in obtaining releases from long term guarantees from the landlord
- Enables the tenant to rent a property from a landlord that might otherwise refuse to rent the property without a personal guarantee
How much do Rental Guarantee Bonds cost?
It depends upon the financial status of the tenant; indemnity period; term of the lease; and the bond amount. This cost is a once only payment upfront that covers the period of the lease.
Who pays for the Rental Guarantee Bond?
This is negotiated between the parties. Typically the landlord will incorporate in the monthly rent or outgoings amount.
What should a landlord do in the event of a payment default by the tenant?
The landlord must notify of a potential claim within 2 months of the first unpaid monthly rental. This is an important requirement, so that we can maximise any recovery possibilities against the defaulting tenant. Claims must be made within 4 months of the first monthly rental payment default, otherwise the claim may be declined. Once a default has occurred, the landlord must consult us before taking action against the tenant.
It’s important to ensure that any rights of recovery against the tenant are maintained.
Can the same Rental Guarantee Bond be applied to a replacement tenant?
No, a new Rental Guarantee Bond needs to be issued in respect of any replacement tenant.
Are Insurance Bonds widely accepted in the market place?
Insurance Bonds have largely been applied to the corporate sector. Several more insurers have entered the market more recently, with a focus on the small-medium sized business sector. The insurers are credit rated with excellent track records in the insurance bond markets.
It’s largely an awareness and education process, however, ultimately it’s at the beneficiary’s discretion whether or not to accept an Insurance Bond.
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