From LeaseRef.com March 15, 2017
Subletting Commercial Space: A Tenant’s Guide
Even if you are the master of doing everything yourself, subletting commercial space should be outsourced to the real estate pros.
Here are the four most important steps in successfully subletting commercial space:
Interview at least three commercial real estate brokerages
Skills and dedication of commercial real estate brokers can vary wildly. Interview at least three. You will learn quite a bit about the market and you may be amazed at the differences of opinion on what recovery each will promise you.
Pro tip: do not just automatically go with the one that promises the highest recovery – this is the equivalent of hiring the cheapest contractor and then you find out when it is too late that you made the wrong choice.
Here are the right questions to ask:
- How long have you been in the business?
- How many subleases have you worked on?
- What is your marketing strategy for my space?
- How long do you think it will take to find a tenant?
- Want rental rate do you think we can achieve?
- Where is the market headed?
- How many other projects are you working on?
- Do you have ample time to work on my sublet?
- Do you have partners or colleagues that can substitute for you if you cannot make a tour?
- What is your relationship with the rest of the commercial real estate brokerage community? Tip: brokers that are not well liked tend to get fewer tours.
- What distribution channels will you use to market my space? (Hint: most brokers do not want to put it out on ALL channels as they will be bogged down with less qualified prospects. Craig’s List is an example. Bonus points for any brokers that include Craig’s List!). The three biggest sources will be costar.com, loopnet.com and 42floors.com. This question will help determine how much subletting commercial space is a specialty for the broker or not.
- Should I make my furniture available?
- Do I need to pay bonus commissions?
- What is your reporting structure?
- Can I see your marketing flyer template?
- How well do you know my landlord?
- How well do you know my building?
Check your lease sublet restrictions.
Most tenants have a number of constraints with respect to their right to sublet. Landlords do want to discourage competition, after all. Once you have an agent appointed (or before), have him look at the sublet clause of your lease.
The common restrictions landlords will have are:
Cannot sublease to other tenants in the building.
These tenants are great prospects for you. You may still want to prospect them – especially if the landlord does not have competing space in the building, you may be able to get away with this one.
Cannot discount your net rent on sublet.
This one is tough since people are expecting a deal when subletting commercial space. The way around this one is to offer free rent to your prospective sub-tenant.
In other words, if you are paying $20 net rent and your lease states that you cannot discount that rental rate on a sublet, then you would have to provide a $20 net rental rate offering, but also offer some free rent into the deal to offset that rent, rather than say offer the space at $15 per square foot.
No subletting commercial space to prospects the landlord has already started negotiating with.
Usually, this one can swing in your favor if the prospective tenant really prefers your space and can exert some influence with the landlord. As the sublet prospect may end up renewing after the sublet term, it can still be a winning situation for the landlord.
No profiting from subleasing – you can only charge a maximum of what you are currently paying.
This would be a nice to have, especially if you are paying well below market rent, but if that is the case at least you should be able to easily dispose of your space at a break-even number.
No advertising a sublet rental rate – the flyer must say Rent: Negotiable.
This one is extremely common. Serious parties will contact your agent to get further details anyway, and they asking net rent can be conveyed verbally.
Must sublet the entire space, not part of it.
In some cases, the space is small enough that it is not cost effective to divide the space anyway (or cannot be done due to fire code).
Subtenant must be at least of your financial strength.
This one can be tough if you have great credit. The landlord may not enforce it though as long as your sub-tenant is strong enough.
No subletting commercial space if the landlord has competing space.
This is the type of clause that should have been removed by your broker or lawyer on the previous negotiation.
Who defines “competing”? What if you are in a building that is large enough that there will always be space available that the landlord deems to be “competing”?
Cannot sublet for a lower rent than the building rental rate.
This one does not make any sense for the tenant. As sublets tend to trade at a discount, your sublease will most likely be at a lower rent than the current building asking rental rate.
On top of that, what if the market is hot, or the landlord is unreasonably asking a rental rate that is too high? You should be in full control of what your sublet rental rate is.
Additionally, you will require landlord consent for the following:
- Approval of the sublease marketing materials at the beginning of the process
- Approval of the conditional sublet deal at the end of the process
Subletting Commercial Space Marketing Plan
You should have been presented with a proposed marketing plan during the interview phase by each of the interviewed brokers. It should have also been a part of your decision to hire the chosen agent. The plan should address the following:
1 Who is our target market?
2 How are we going to target the target market?
3 What proactive steps will we take to contact our prospects?
4 What commercial real estate databases and distribution channels will we leverage?
5 What resources are dedicated to disposing of the space? Junior brokers making cold calls, hand delivering flyers, open houses, etc.
6 What is the reporting structure? Weekly, daily?
7 How are we going to differentiate the space from what it competes with?
By the way, in case you do not already know, there is a general relationship that exists between sublets and direct space and short-term sublets vs. long-term sublets.
First of all, sublets are typically traded at a discount relative to direct space. That is because companies looking to get rid of their space want to get on with life and landlords have more patience since they are in the real estate business.
Subtenants are also hunting for a bargain and want a discount associated with the extra risk of a sublet (dealing with another tenant instead of a steady head landlord).
Secondly, there are fewer prospects for shorter term leases. Most companies do not want to move for a short period of time. If the market is hot the sublet rental rate is less affected.
But as a general rule, the shorter time left on the sublet term, the more the sublet rental rate has to be reduced to be competitive, relative to competing space options offered directly from landlords at 5 and 10 year lease terms:
Approach with Employees, Suppliers, and Clients
Subleasing can be a touchy thing – people make assumptions. When a company is subletting commercial space, most people make negative assumptions first – they think a company is having troubles paying rent so they are downsizing.
Employees tend to get very nervous about company relocations. Even when a company is doing well and subletting to expand, employees think about their current status quo and a move away from that may disrupt their routines.
For this reason, most broker marketing materials do not include a suite number or a picture of the client’s signage within their marketing pictures.
You should have a discussion with your broker on what he will tell other brokers and prospective tenants on why the space is on the market. You should similarly have a chat with employees before people in suits regularly tour through your space.
Bonus Material! Other things you should know about:
Landlord Sublet Approval Time Period
Check your lease to see if there is a time period the landlord must abide by to provide approval of your subtenant. Some leases state a time period (like 10 business days), and others use broader language like “reasonable time period”. Some leases say that a landlord cannot unreasonably withhold consent, but do not state a timeline.
Make sure you account for this delay – in some cases, the landlord takes too long and your subtenant ends up walking from the deal.
Without the landlord approval, you will not have a deal. Here are the three elements you need:
As the sublandlord, you will be paying all of the real estate broker commissions. Normally they are split 50/50 with your listing agent and the co-operating broker, or they are 1/3 to your agent and 2/3 to the co-operating brokerage. Of course, it is only paid if a deal happens.
Note that you will also have to pay for the landlord’s cost to review the sublease agreement and approve the deal. Your lease may state what this cost is. Most of the time it just says it is a reasonable amount – and that normally means about $1,000.00.
Risks of Sub-Tenant Defaulting
Subletting commercial space does not mean you are completely off the hook. If the sub-tenant stops paying rent to you, you still have to pay the full amount to the landlord.
Remember, you have a legal contract with the subtenant, but the landlord does not. The landlord approved the subtenant but has no legal relationship with them. So you must ensure you are subleasing to a tenant you trust will pay the rent for the entire sublease term.
Subletting Only a Portion of Your Space
It may make sense to divide your space and only lease a portion of it. That would save you from having to move and find a new location. In many cases a tenant does not have the right to sublet just a portion – it will depend on what the sublet clause in the lease says. It may be wise to get a lease abstract company provide a review of this clause.
Subletting for Less Than the Lease Term
Unless your lease specifically states otherwise, you can sublet for less than your remaining lease term, but in most cases, it would not be practical for you to do so. This would be more applicable in the case of subletting a portion of your premises. You could sublet for a period of time and then recapture the space back. This could be useful if you have a cyclical business.
What Tenant Rights are Transferred to the Subtenant?
Generally the entire lease and all tenant rights are transferred to the subtenant, however, there can be resistance from the landlord. Wise landlords are explicit in their leases as to what is transferable and what is not.
For instance, in most signage clauses, it will explicitly state that building signage is not a right to be transferred. Normally lease renewal rights are also not transferred to a subtenant.
Other Sublet Checklist Items
1) Ensure your subtenant obtains an insurance certificate
2) Ensure your subtenant informs you of any alterations they will be making to the premises
3) Try to get post-dated checks, or set up an automated bank payment withdrawal method
4) Have the subtenant submit a security deposit with their offer, held by your real estate agent, not theirs
Conclusion on Subletting Commercial Space
Subletting your commercial space (whether it be retail, office, or industrial) is not an easy task. Unfortunately, it is not easily handled by yourself and there really is not any easy solution for this except for interviewing commercial real estate brokers, educating yourself on the lease, and hoping for some good luck!