To Sublease or Not To Sublease…..
That is the Question I Ask Thee
By Dan Granot, Advantis Real Estate Services Company
One of the largest annual expenditures for a company of any size is the cost of leasing an office facility. For this reason, many companies consider a sublease when they are evaluating their options for office space. Though a sublease can provide an opportunity for substantial rental savings, a company must carefully evaluate each sublease opportunity to determine whether or not it is a good fit.
A management team and its real estate advisor must prioritize a number of factors when evaluating a sublease including:
- What are our “all-in” costs?
- How does this space reflect our current and future operational needs?
- Does the location and image of the facility promote employee satisfaction and retention?
A sublease is typically marketed at a fraction of the cost of a “direct” lease with the owner of the building. The sublessor has typically vacated the sublease space and it wants to recapture part of its rental loss. The condition of the sublease space, the amount of time remaining on the lease term, and the overall strength of the office market are factors that will affect how large or small the rental discount will be. With the right sublease opportunity, a company can credit rental savings directly to its bottom line, or it can use the discount to upgrade the profile of its office facility without paying “market” rental rates.
A sublease also gives a company the opportunity for a short lease term because a sublease is often marketed in the final years of the sublessor’s lease obligation. This can be critical for an emerging company that does not want to commit to a long-term lease. It can also be helpful for a firm that is establishing a satellite office, creating a new or separate business unit, or one that is in a transitional phase. A sublease can provide an interim location until a more permanent direction is established.
A subtenant can also typically occupy a sublease without providing significant credit enhancements. Because subleases are usually leased on an “as is” basis, there are few up-front costs to the sublessor, and credit enhancements such as a personal Guaranty or a Letter of Credit aren’t as critical. The sublessor is negotiating from a position of weakness, so it will also pay less attention to the overall financial strength of the subtenant. This dynamic is especially appealing to young companies and their investors.
There are some potential drawbacks that a tenant must also consider before entering into a sublease agreement. The structure of a sublease deal does not typically include an allowance for tenant improvements, so a potential subtenant must also determine what additional costs it will incur in excess of rent. Any space modifications, including reconfiguration of partitions, or the addition of security, phone and data cabling, specialized technology equipment, and supplemental HVAC, will all be the sole cost of the subtenant. These costs can eat away at the discount in rent that a subtenant hopes to enjoy.
The rights of a subtenant under a sublease are also dictated by the terms of the initial lease, and these terms are typically non-negotiable. This situation can limit a subtenant’s allocated parking spaces, and rights to renew, expand, or audit a landlord’s book of operating expenses. These are all items that an advisor would typically negotiate in a “direct” lease.
A sublease can be a viable option for many companies, especially emerging and transitioning firms that may still be searching for their ultimate identity. By carefully considering the trade-offs of each opportunity, a company can find the deal that will save 10%-50% on its annual rental outlay.
By: Dan Granot