Are Personal Guarantees for Commercial Leases Really Necessary?
Most of us have heard the anecdotal advice that you should never mix your personal and business finances – which leaves many business owners (tenants) and property owners (landlords) uncertain of whether personal guarantees for commercial leases are acceptable.
The short answer is … absolutely!
In fact, personal guarantees are an incredibly important risk mitigation strategy for landlords – especially those smaller landlords who would be deeply impacted if a commercial tenant defaults on the lease.
What Are Personal Guarantees in Commercial Leases?
Just like in the residential rental market, commercial property owners want to rent to tenants who have great credit, a proven history of paying bills on time, reliable cash flow, and relatively low risk of suddenly being unable to meet their obligations. However, that can be a difficult standard to meet for many small businesses, start-ups, new restaurants, and retail shops. In fact, even something positive, like a recent growth spurt, can send red flags to a potential landlord. This is where personal guarantees come into play.
Just as it sounds, personal guarantees for commercial leases are contractual agreements that hold the business owner(s) or executive(s) financially liable for the lease in the event that the business entity defaults.
For example: if a company goes out of business four years into its five-year lease, the business owner’s personal guarantee means he or she will be personally responsible for paying that last year’s rent to the landlord.
It may sound like that is a good deal for landlords but a bad one for tenants. However, that’s not actually the case.
How Do Personal Guarantees Help Commercial Tenants?
Without personal guarantees for commercial leases, many companies would be stuck in a “chicken or the egg” scenario. They need to have great credit and reliable cash flow to lease their ideal space but can’t generate consistent revenue if they aren’t in the right location. In other words, they need that ideal commercial space in order to grow into an “established” company with steady sales and reliable customers. Personal guarantees give those businesses a way to get approved despite not yet being able to meet the high standards of commercial landlords.
Why Are Personal Guarantees Important for Commercial Landlords?
There’s a reason commercial leases often have personal guarantee clauses. Before the 2008 recession, they were less common but at the peril of the many landlords who were left with vacant spaces, mounting bills, and financial losses when their tenants went bankrupt.
Realistically, personal guarantees aren’t necessary in all types of commercial leasing. There’s a different level of investment for landlords who rent office space compared to those who rent retail storefronts, restaurant locations, and industrial properties.
Here are some questions to consider when weighing the pros and cons of personal guarantees and commercial leases:
- Are there tenant improvement costs to consider, and at what point in the tenant’s lease will I recover those costs?
- What level of demolition and renovation would be required for the space to be ready for a new tenant?
- Based on the local real estate market, how difficult would it be to find new tenants?
Whether you own large commercial properties or a smaller one, it’s important that you understand how to protect yourself, what can be negotiated, and what should be non-negotiable.
Get the Representation You Need for Commercial Lease Negotiations
Your Southern California real estate specialists. Allwest Properties, Inc. offers a full range of real estate services for commercial, industrial, and multi-family residential properties throughout Los Angeles, Orange, San Diego, Riverside, and San Bernardino counties.
With more than 25 years of industry experience, we offer a comprehensive suite of solutions, including sales, leasing, tenant representation, landlord representation, leased investments, site selection, and consulting services. Our goal is to exceed our clients’ expectations with each and every transaction.
Contact us today by calling 888-400-2966 or emailing info@allwestproperties.com.