Over the past three quarters, office sublease offerings have doubled in count and industrial Sublease offerings have increased by 30%. What does this mean? More importantly, what does this mean to you?
I’ll first explain what may be driving this spike in subleases. One reason that companies present their office space for sublease is because the volume of their business contracts. This may be due to one or several reasons: a weakening business, industry issues, widespread economic recession, increased government regulations or consolidation. Other reasons for an increase in sublease activity in the market may be business growth/expansion, desire for ownership of commercial real estate or merger/acquisition – among other drivers.
Some potential benefits of subleases are as follows: Limited lease term, available furnishings, less underwriting of creditworthiness, and/or motivation on behalf of sublessor resulting in financial incentives. Some potential drawbacks of subleases are as follows: No explicit rights to extend the lease or expand, adherence to the general terms of Sublessor’s Prime Lease, less influence with the Prime Landlord, and unlikely ability to secure early termination or contraction rights.
A word of warning: Some national companies end sublet terms one month prior to the end of their term so that they may prepare the space for return to the Prime Landlord. What happens if the Subtenant wants a new direct lease with the Prime Landlord upon expiration of the Sublease and there is a 30-day differential? It is probably easily cured with an early release of the Prime Tenant/Sublessor by the Prime Landlord, but it could complicate matters. It’s best to verify that the expiration date of the sublease matches the expiration of the Prime Lease.
In terms of the furnishings, in your agreement with the Sublessor, try to take ownership of them at the commencement of the sublet term or the expiration of the term – preferably at no cost to you. The sublessor may gladly convey ownership to you because it can be very expensive to relocate office furniture and they may not need it at the time or in the future. Sometimes office furniture is liquidated for a fraction of its value; however, its value can be very significant for you. Inheriting furnishings can profoundly reduce non-recurring initial costs.
The fact that subleases are becoming more abundant means the following to consumers of office space: 1. Sublet space competes with direct space, so not only does it provide an opportunity to get a below-market rate, but when tenants lease sublets rather than direct space, it may increase time on the market for competing direct space and soften that market as a result. 2. In some cases it is easier for start-up companies or those with adverse financials to be underwritten. With direct space, landlords often have lenders that scrutinize financial wherewithal of the prospective tenant, whereas with subleases, as long as the Sublessor company is satisfied with the formula for security or credit enhancement, they are more easily approved. 3. More choice for office tenants. Although sublessors are resistant to modifying the interior configuration of sublet spaces, sublets are additional options for tenants in the market.
Finally, in some cases, subleases may be the initial component of a tenancy. Frequently, landlords will simultaneously negotiate additional term for a tenant that triggers upon expiration of the sublet term – so that a subtenant may have the benefits of the sublease opportunity, but with some predictability and rights later. A landlord will do this to shore up their rent roll. Some of these rights in the “wrap-around term” may include an improvement allowance from the Prime Landlord, as well as expansion and renewal rights not available with the sublease only. This way the tenant gets the best of both worlds: subsidized savings in the sublease portion (when it applies) and flexibility rights in the wrap-around portion.
Subleases are great opportunities for some companies. For others, they are not the right solution for one reason or another. Every company’s space solution is different. The best way to evaluate your company’s office space needs is with the professional guidance of an expert ‘Tenant Representative’ that can objectively illustrate for you the merits and drawbacks of each transaction under consideration.