Unfortunately, circumstances arise when a company no longer has use for commercial space it has leased. Needs may have changed regarding the size of the business or location, or a company may have experienced financial reversals and must rid itself of the unnecessary expense. Whatever the cause, unwanted commercial space is expensive. Companies holding such leases are hemorrhaging money every month and want relief fast.
“The larger the square footage and longer the lease term, the greater the exposure,” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “Maximizing time and efficiency is vital to properly sublease space and mitigate losses.”
Smart Business spoke to Chavez about the few important steps companies should consider before taking their space to market.
What should tenants consider first when looking to sublease space?
First, read the sublease and default sections of your lease and be aware of any sublease restrictions that may exist. Landlords’ ‘form’ leases often prohibit subleasing to existing tenants in their building, or to companies with whom the landlord is engaged in active negotiations. Likewise, governmental organizations with high traffic count, or the Internal Revenue Service, for example, may be excluded because the landlord deems them an unfit occupant of their building. It would be most unfortunate to spend time and money negotiating and documenting a sublease only to find out in the 11th hour that the proposed subtenant is prohibited.
How can they improve the chances that the space will be sublet?
Have a solid marketing plan. Interview real estate brokers that are active in your market. Understand exactly what measures they will employ to sublease your space and keep you informed. Know their track record and ask for references. Make certain that any listing agreements they may have in the area are not actually conflicting interests. Such brokers may be more beholding to their landlord clients, as they are simply the bigger fish. Ask if the broker can show you a ‘sublease recovery analysis.’ If they do not understand this concept, it may be wise to move on.
It is imperative to understand the subtleties in your market and price the space properly. Pricing the space too high will likely cause the space to sit vacant and allow the financial hemorrhage to continue. Price too low and money is left on the table unnecessarily. The balance between price and timing must be carefully addressed early and clearly. Discuss commission incentives and see if they are commonplace in the market and likely to bring better results.
Also, be certain that your broker has the ability to find tenants that are actively seeking space in the market. All too often sublease space is listed on a marketing service website and brokers wait for the phone to ring. The likelihood of success is enhanced if your broker has an active and well-conceived marketing strategy. Subleasing space properly is more work, so be sure to agree upon a reporting process and keep your brokers accountable for weekly activity reports.
What other challenges must be overcome?
Unless the real estate market is ‘white-hot,’ subleasing space is difficult. Unlike the building owner, a tenant (or sublandlord) only has its specific amount of space, design and floor plan available. Sublandlords are seldom in a position to spend vast sums of money retrofitting their space to suite another occupant. Accordingly, the target audience for subleases is dramatically reduced as compared to what a landlord can offer. Pricing the sublease space below the landlord’s rates is often the only viable way to quickly sublease the space. Timing is extremely critical. It does a company little good if their space works nicely for a particular company but they cannot occupy for 18 months because that is when their lease expires. This would cost a company with 10,000 square feet nearly a half-million dollars in rent just waiting for the subtenant to become viable.
What are the final steps once a subtenant has been identified?
It is important to qualify the company before agreeing to final terms. Be certain to review financial statements and research the company as well as their industry. You want to be as certain as possible that the subtenant will continue to pay their sublease rent. The last thing a sublandlord needs is to spend even more time and money evicting a deadbeat subtenant, and then have to start the process all over again.
Inform your landlord in writing once you decided to sublease space. This may expedite the landlord’s consent process, which will be required to consummate the sublease. Additionally, you may get lucky and the landlord could elect to ‘recapture’ the space if they have another party interested.
In rare instances, a sublandlord may be able to profit from subleasing space due to an upward trend in market conditions. This is more typical in a retail setting, but can happen in office or industrial sectors as well. Once again, look to your lease before celebrating. The landlord may be entitled to all profits if the lease was poorly negotiated. If that is the case, the tenant might as well sublease the space at its below-market rate and a find subtenant much sooner. Again, read your lease, as you may not be permitted to undercut the landlord’s rates. Most commercial leases are ultimately drafted such that the landlord and tenant share any sublease profits on a 50/50 basis, after the tenant has recovered reasonable fees for commissions, improvement allowances and other marketing expenses.
As you can see, subleasing space is no fun. There is little certainty with regard to the outcome and very limited flexibility. The best defense is to plan ahead and exercise extreme caution when entering into a lease in the first place.
Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at [email protected] or (310) 882-2060.
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