The Value of Rental Deposits Norman Hutchison,

Transcript:The Value of Rental Deposits Norman Hutchison,:
The Value of Rental Deposits Norman Hutchison, Alastair Adair and Kyungsun Park ERES, Milan June 2010 Background Income key driver of property return Risk of default depends upon covenant strength of tenant and stage of cycle - see Hutchison et al. (2009) Default could result in a substantial period with nil cashflow: period to regain possession, possible lengthy void period, followed by rent free period In UK deposits are not uncommon, but if they do exist they normally amount to 3 to 6 months of rent. Research Aims To consider the negotiating strength of landlords and tenants in lease negotiations To consider the well established deposit system in South Korea for lessons that could be learned To calculate the level of deposit which is necessary to mitigate income risk Literature Review Professional literature (little academic?) on incidence of rental deposits in the UK Previous work has focused on the differences in negotiation strength at rent reviews, lease renewals and open market letting McAllister and Tarbert (1999), Crosby and Murdoch (2000). But large literature on well established deposit system in South Korea Negotiating strength in a cyclical environment Level of deposit, if any, depends upon the negotiating strength of the parties at the commencement of the lease. Other factors maybe more dominant: level of rent, length of lease, rent review frequency and terms, repairing obligations break options etc. e.g. During downside of a cycle: a)Landlords anxious to get property let willing to offer rent free periods + other incentives b) Tenants Unwilling to pay deposits - business uncertain Access to bank finance to fund a deposit problematic ? South Korean Lease Contracts -Jeonse Contracts 3 types of lease contract: Jeonse, Walse, Jeonwalse Jeonse contract : tenant pays upfront deposit with no periodic rent payments Jeonese deposit 40% to 80% of property value Landlord can earn return on deposit , and must only return deposit at end of lease Eliminates 100% impact of tenant default Outside Seoul, 84% of office contracts use Jeonse In Seoul, Jeonse ratio is only 22.8% South Korean Lease Contracts -Walse Contracts Walse Contract Tenant pays a security deposit and monthly rent Security deposit normally equivalent to 10 months rent Amount of monthly rent linked to Jeonse deposit Unpaid expenses can be deducted from deposit Min lease: two years, max lease: 5 years In Seoul,77% of all office leases contracted on this basis. South Korean Lease Contracts -Jeonwalse