How Do You Negotiate over Deposits?
Deposits, the cleaning and security kind that tenants give to land lords to hold during the tenancy, may seem like small potatoes. But in recent years they have become increasingly important. In fact, in some cases they are the deal point around which a sale hinges. How can this be? It’s all a matter of cash.
There’s a very old joke that goes something like this. Sal and Pete are talking and Sal says, “I’ve got good news and I’ve got bad. Which do you want to hear first?” Pete says, “What’s the good news?” To which Sal replies, “They’ve accepted our $10 million offer for the office building.” “Great,” Pete replies, and then asks, “So, what’s the bad news?” Sal answers, “They want $500 in cash!” The truth of the matter is that most investment property deals are heavily financed. The buyer frequently puts little cash money into the deal. But there is always a great need for cash—to pay off the agent’s commission, the closing costs, and the seller.
In an income property transaction, except for new financing, the only real cash in the deal sometimes may come from security/cleaning deposits. Consider the following. There’s a 25-unit apartment building. Rents are $1,000 a month, making the price roughly $6,000,000 (assuming a multiplier of 20). That’s a fairly large number. But, chances are it’s not a cash number. Presumably, the buyer is going to finance most of it, perhaps all of it, with even the seller carrying back a substantial amount of paper.
Except for the deposits.
Let’s say that each apartment puts up one and a half times one month’s rent in a cleaning/security deposit. (Currently that’s the maximum allowed in some states.) That totals $37,500.
If the owner has simply spent this money as it comes in (hoping to pay back the old tenant’s deposit with the deposit from the next tenant), negotiations should deal with how to credit that money to the buyer. Other times, the seller has carefully kept that money in a bank account. Now negotiations center on whether the seller gets to keep it or whether it’s transferred to the buyer.
Since the deposits may be a significant part of the cash involved in the sale, it’s a big deal point, and very often trade-offs in terms of price and financing can be made with it.