Your lease will expire in the next 12 to
18 months. You want the best value
for your money and maybe staying in the current space is an alternative. Should
you expect help from your landlord or your
landlord’s broker? Will this approach bring
out all of the market alternatives or just the
ones that suit the best interests of the landlord … or the landlord’s broker … or the
other landlord clients of that broker?
According to Mike Gallagher, vice president of Irving Hughes, there is an underground of available sublease space, much
of which is quietly on the market only to
those who are really in the know.
“The San Diego commercial real estate
market is not much different than the New
York night club scene — you have to be
connected. There are 4.3 million square
feet of sublease space on the market in San
Diego today, and even more than that is out
there that’s not listed and quietly available.”
Smart Business talked to Gallagher
about the San Diego commercial real
estate sublease market and what to consider as options for leasing space.
What causes sublease space to become
available?
Prior to the 2000-2002 tech downturn,
there was traditionally very little sublease
space available and tenants and their brokers didn’t focus much on it. Initial waves
of sublease space came on the market in
2001 when tech and related service companies began to downsize. Since then, the
market has been filled by subleases of
large companies downsizing their San
Diego operations like Intel, Nokia, Merck,
Pfizer and Eriksson.
A vast amount of the sublease space on
the market today is the result of merger-and-acquisition activity whereby a San
Diego company gets gobbled up, and the
result is that the acquiring company cuts
the local headcount and looks to dump the
real estate. In the last year, the slowdown
in residential real estate has caused several hundred thousand square feet of sub-lease space to come on the market as the
result of downsized mortgage companies.
Why should a company consider a sublease
opportunity?
The first is financial. You will save a ton of
money relative to leasing space directly from
landlords. Companies that need to sublease
space will have to discount their space in
order to sublease it. In most San Diego office
submarkets, the average time the space has
been listed for lease ranges from 11 months
to 19 months, and it’s almost two years in
UTC. The sublessor can’t wait that long, and
cutting the bleeding quickly is the primary
concern. Where a landlord is trying to maximize revenue when leasing space, a sublessor is trying to minimize losses.
Another benefit is flexibility. The majority
of subleases range from one to three years
but sometimes they can be longer term, or
the term can be extended with the landlord.
Many start-ups or tenants with softer credit
find shorter-term subleases attractive. When
signing a direct lease for space, landlords
want to see the last two years’ tax returns and
they do heavy credit checking, which can
ultimately result in higher deposits or personal guarantees. We generally avoid this risk
and cost with subleases.
Another benefit is that many subleases
come with furniture, network cabling and phone systems available, which is generally included at no additional cost, all of
which the subtenant owns at the end of the
term. There is nothing like moving into a
plug-and-play situation and saving hundreds of thousands of dollars on equipment.
Are subleases usually available?
As of this writing, there are 22 high-rises in
downtown San Diego, all of which have multiple options available in a variety of sizes.
Many subleases are available from law firms,
but they are not publicly on the market due
to the sensitive nature of how it would
appear to employees; downsizing can be very
traumatic for any professional firm.
Approximately 20 percent of our downtown clients are going into sublease space
and 15 percent of our suburban clients are
closing on subleases rather than leasing
space directly from landlords. This is
where the values are and this overhang of
space is going to have to materially move
off the market before landlords will be able
to increase overall rental rates.
Are there pitfalls in subleases?
The biggest risk is credit. You need to
know as much as possible about who you
are subleasing from. You want to assure
yourself that the sublessor is paying his or
her rent to the landlord while you are paying the rent to the sublessor. A subtenant
should also make sure that none of the furniture available is leased. Also, a subtenant
will want to make sure operating expenses
are not passed through, as the sublessor
will have a base year that is several years
old, and this can create a surprise cost.
Subleases universally come in as-is condition but we are able to negotiate free rent
concessions to offset the costs of any tenant improvements or alterations. Again, it
is important to work with a representative
that is connected and experienced in this
unique market of transactions.
MIKE GALLAGHER is vice president of Irving Hughes in San
Diego. Reach him at [email protected] or (619) 238-4393.