Got too Much Space? Sublease it. Vincent Bajardi, CCIM Senior Advisor (314) 719-2069 vbajardi@gundakercommercial.com For those of us who have been in the real estate business during challenging economic times, 2009 will certainly be a year of change. The sublease market will be a dominant theme in the coming year fueled by corporate restructuring and downsizing. Companies are beginning to place a lot of sublease space on the market. It is important to know how valuation and marketing of sublease space can differ significantly from direct lease space. This article is a resource for business leaders and entrepreneurs who may be faced with subleasing their space. In many cases, the reason sublease industrial space becomes available has nothing to do with the real estate market. Most likely, a company has decided to reduce inventories, downsize, change geographic locations, sell off divisions or subsidiaries, or otherwise restructure company operations. As the economy has slowed recently, companies are forced to reduce staff and inventory to reduce costs by finding other companies to sublease to and offset rent expense. (Note: a Sublessor is the entity trying to sublet their space to reduce their lease financial obligation; a Sublessee is the entity who would be the tenant taking over the space from the sublessor. The Prime Landlord is the owner of the property with whom the sublessor did the original lease). Reviewing the Options Business leaders need to remember: the primary objective of subleasing is to reduce or remove the lease/rent obligation. This can be accomplished in four ways: the buyout, the sublet, the recapture and the write-off. This article will focus on the most common approach: subleasing. Before proceeding with a plan to sublease, it s best to check with the landlord to see if they would consider a lump sum dollar buy out of the lease. Sometimes, landlords can use the cash or need the space to accommodate another expanding tenant so, it can t hurt to ask. If that doesn t work out, the next option is trying to sublease the space. Once the decision is made to sublease a portion or all of a company s space, the company/sublessor needs to find a replacement: a sublessee. Once a sublessee is identified, the sublessor goes to the primary landlord to approve the sublease. The landlord usually reserves the right approve all subtenants based both on the sublessee s credit worthiness and intended use. Landlords want to insure sublessees are reasonably consistent with the quality of other tenants in the complex and conform to the use of the space.
Even if a sublease takes place, the sublessor still remains liable to the landlord for the financial obligations in the original lease for the duration of the lease. Also, in many leases, options given to the original tenant by the landlord don t necessarily transfer to a subleessee. For example, options to renew the lease or expansion rights may not be granted to a subleessee. The sublessee should attempt to find out from the landlord under what conditions rights or options would be transferable. It s important to read the Sublease and Assignment section of the primary lease before setting forth to subletting a space. Documenting the Sublease In a sublease, the sublessee is also agreeing to the terms and conditions in the primary lease which is important for a sublessee to know. Negotiating changes to the primary lease with the landlord does not usually occur simply because landlords aren t obligated to do so. The Sublease Agreement is actually a relatively short document, usually 3 to 4 pages plus the Landlord s Consent to Sublease document. The sublease document typically lists the parties to the transaction, summarizes the business terms, has a floor plan and signature blocks for the sublessor and sublessee. A sublease agreement can be obtained from a lawyer or broker. Once the sublease agreement is signed, it must be presented to the landlord for their approval. Landlords typically have the right to decline a sublessee so it s important to know up front if the landlord may decline certain subtenants. It is also a good idea to use the landlord s version of the Landlord s Consent to Sublease document. Many landlords don t want to spend time and legal work to review an unfamiliar document which can delay their approval. Some landlords charge tenants a fee to review and approve a sublease so, it s important to check the original lease. How to Locate a Sub-Tenant: Keeping a Competitive Edge Available sublease space competes not only with direct-lease space in the marketplace, but also with other sublease space being offered typically at greatly reduced rental rates. It might also be directly competing with the landlord s space within the same building. In general, benchmarks of a competitive industrial sublease space include: The remaining term on the lease. More than two years is best; less than two years is a disadvantage. Having an open layout or traditional configuration. If it s non-traditional space, sublessors may have to spend their money to make renovations to
make it suitable to a sublessee. Having a flexible and cooperative landlord. Being a highly motivated sublessor. Offering existing racking systems or phone/it systems with the deal. The timing of when the space is available for occupancy. If the space is traditional office / warehouse space, it usually results in the space being leased as-is. You can get this information by talking with an experienced industrial broker familiar with sublease space and the market wherein the space is located. Another consideration is whether the entire space is being subleased or only a portion of it? If it s only partial, where is the space to be physically separated (demised)? How much will that cost? There is also the opportunity to simply co-habitat with a sublessee and share facilities. In such a case, there must be a high level of trust between the parties. If the space is particularly large, another option is to divide the space into smaller sub-leasable areas. A qualified architect, tenant improvement contractor, or subleasing specialist might be brought on board in the very beginning to help identify costs. Their input may determine whether the space can be subdivided, and if so, how best to do it. Having the space planner and contractor on board in the initial stages helps to lay out the space and identify potential subdivision strategies. The tenant may decide that an as-is, all-or-nothing sublet will recapture more rent at greatly reduced rental rates than dividing the space with a tenant improvement allowance and offering the space at dramatically higher sublease rents. On the other hand, a tenant vacating a portion of their space might also consider the overall economic impact of vacating the entire space, it greatly increases the chance that the space will be sublet. If a company decides to downsize and sublease their space, it is not realistic to market the space for sublease with the plan to find alternative space once a subtenant has been identified. It takes a minimum of 3+ months to locate, negotiate, and move into new space and most sublessees will need space sooner than that. Plus, they have no guarantee that the sublessor can find suitable space in a timely manner and won t want to run the risk of having their move delayed indefinitely. If there is a lot of sublease space being offered in the market, it s highly probable that other available sublease spaces will be more readily available for them. Marketing Sublease Space A company may choose to market the space on its own because it is trying
to save sublease commissions, or to justify the employment of their in-house real estate staff. The fact of the marketplace is that industrial brokers represent 80% to 90% of all the warehouse / distribution / manufacturing tenants, depending on geographical market differences. This means a company will likely have to pay a sublease commission if they want the best exposure for their space. It seems to be a better use of the firm s money to have the space listed and marketed professionally, with the listing agent sharing his or her fee with the procuring agent. In the case of non-listed or open-listed (with no one agent responsible) sublease space, an out-of-sight, out-of-mind effect comes into play and often no agents show these spaces to prospective tenants. The corporation usually does not have someone with time or expertise to do all the marketing activities needed to sublease space, and that is why most Fortune 500 corporations list excess space with a professional leasing firm. Just like trying to sell your home, the space should be in well-maintained, marketable condition. While it is usually not prudent to renovate the space prior to obtaining a subtenant, shampooing the carpets, repainting, and other minor repairs are monies well spent. The sublessor should keep the lights in good working order so that the space can be shown, and give the keys to the subleasing agent so that all parts of the vacant space are readily accessible. For major space presentations, it might be wise to turn on the HVAC system before the tour so that the space is comfortable for viewing. Debris should be removed from the warehouse and the vacant space shouldn t be used to store old equipment and supplies; this weakens the marketability of the space. Many of the marketing functions in direct lease space also applies to subleasing. Marketing materials, including fliers and floor plans, are prepared and distributed to the brokers active in the marketplace. For larger sublease spaces, marketing may occur on a regional or national basis as well. Mailers are sent to potential tenants on the listing broker s mailing list and handed out during personal cold calls to businesses in the geographic area where the space is located. This will give the space and all marketing efforts a professional presence. A broker open house is one way to generate prospect activity, depending upon the size of the sublease space and its remaining term. For smaller spaces a broker open house is usually not practical, but for larger spaces this can be quite beneficial. The objective of these affairs is to make the brokerage community aware of the sublet space availability in order to compete with direct space marketing at a competitive level. Making it Worthwhile for the Broker Generally, a sublease may take three to five times more effort than does
a direct listing. Therefore, it might be prudent for the tenant faced with subleasing to consider paying a higher commission if this will increase the chance of successfully subleasing the space. Subleasing commissions are always negotiable, but generally speaking, in order for sublease space to compete with direct leasing, commissions should also be competitive. Brokers have the contacts and bring the potential sublessees to the property, so it may be beneficial to offer a competitive commission to entice brokers to keep the space in mind. As an example, an agent faced with placing a prospect in a direct lease that would earn a 5% commission fee for a five-year term might consider a 10% fee equivalent compensation for a 30-month sublease. Again, each circumstance is unique, but unless a company is willing to pay a good fee, brokers may not be as eager to bring in potential sublessees. The tenant should keep this in mind when determining sublease compensation packages. Putting a Price Tag on Space A sublease will only help companies re-capture some of their monthly rent. Factors that help determine how much to advertise the price of the sublease space will be influenced by the existing layout, the condition of the local office market, the length remaining on the primary lease, and the overall contract rent as compared with market/direct lease rents. If a tenant signed a lease when the market was tight and rents were high, there may be a good chance that their contract rate (what they re paying according to their lease) maybe higher than what space is being marketed in a soft market. Nevertheless in most cases tenants will discount their rates from 20% to 75% of the current lease rate. An experienced leasing broker will be able to provide market survey information that will enable the tenant to price the sublease space appropriately. Because a sublease is time-sensitive, it is prudent to aggressively market the space with the price substantially discounted from the beginning of the sublet. An alternate strategy would be to market the space at a slight discount if the space still remains available after 90 days. Additional Tips on Subleasing Seek professional advice from an industrial leasing broker. They will be able to break down the sublease process and help you be most competitive. Take your ego out of the decision. Special details to the available space or things you may think are big selling points because they are special/ important to you may not be to a sublessee. Don t get greedy. Subleases can come together relatively quickly once parties start negotiating. A common mistake is for a decision maker to try and make it a big negotiation especially if subtenants have a lot of choices. Focus on getting a reasonable deal as quickly as possible.
Companies wanting to sublease their space will frequently look to the building s leasing agent or property manager for assistance in marketing because of being familiar with them. Unless the building is 100% occupied, doing so may be a conflict of interest. If a prospect calls for available space, they may be influenced to steer tenants to their remaining vacancies. In most cases it is more attractive to market sublease space with the racking included if you own it and not the landlord. It may be reasonable to negotiate a separate monthly rent for use of racking. This allows you to keep the sublease rate low and get additional income from a separate lease agreement. (Your broker should not be entitled to collect a commission on rent you will receive in a separate lease or sale). If you re willing to include the racking at no additional cost, that is optimal. It should also be clearly determined who owns the racking at the end of the lease. In many cases, the sublessee can get an option to purchase the racking. Check the financials and credit history of a sublessee to make sure they re strong. Negotiate a suitable security deposit and hold it as the last month or two s rent. Be sure the sublease agreement provides that the sublessee pays for any additional costs associated with their occupancy of the space or if they request the landlord to perform special work. Many leases provide for base year operating expense pass through payments from the landlord. When sharing the space, it does not make sense for tenants to calculate some kind of pass through charge to a sublessee (much less dedicating staff time for someone to figure it out each year). If it s an issue, it is easiest to negotiate a simple annual automatic increase of 2%-3%. Subleasing is a race. Give serious consideration and evaluation to your first prospect. Passing on a deal you think is too low could result in waiting months for the next prospect. Many times, tenants are financially better off taking a lower deal early in the game versus paying a number of months of full rent and seeing another low-ball deal. Many subtenant prospects see subleasing as being a great way to get into great space for a relatively low cost; and they re right. The downside for many sublessees is when the original lease expires they will be faced with negotiating directly with the landlord for what s likely to be substantially higher rates. This scares many prospects especially if the sublease term is less than 2 years. As the prime lease nears expiration, be sure to give the landlord ample notice that you will NOT be renewing the lease. Also, be sure the sublessee vacates the space at expiration. If the sublessee holds over (i.e., remains after the lease expires) the tenant may incur hold over penalties from the landlord.