What Can Make a Sublease Unmarketable - 5 Situations

I recently wrote about the Yin and Yang of subleases wherein I discussed the elements which make a sublease risky and non-beneficial to the owner and occupant of a building - “because subleases are generally unfavorable to the original occupant (sub-landlord) and owner (master landlord), risky, and complicated.” Also discussed was a definition of a sublease - “What is a Sublease? When a tenant must relieve himself of a lease obligation prior to the expiration of the lease, the need to sublease occurs.”

Today, I embark on an explanation of the five situations which can cause a sublease to be unmarketable.

The term of lease. We toured a space yesterday being marketed for sublease. A decision to vacate prior to the expiration of the lease was made by an occupant whose corporate headquarters are out-of-state. Now fifteen months remain on the lease obligation. Akin to a well shopped clearance rack at Nordstrom - the short term will appeal to very few occupants. You see - generally - a three to seven year term is sought by prospective tenants. A move is expensive, disruptive, and quite inefficient. Most are unwilling to move only to do so again a year later - if extension terms can’t be reached with the owner of the building.

Uncooperative owner. Owners ride the length of their leases through market swings. In the example above - additional years could be tacked onto the fifteen months - if - the owner will play ball. Where we are in a market cycle - up or down trending - can predict how a landlord will react to a request for a longer lease. If our market is improving - he has no incentive to strike today. Storm clouds on the horizon? Yes! Let’s deal.

No concessions. A tenant with remaining years on their lease wants out - as quickly and cheaply as possible. Consequently - requests for changes to the space - at the tenant’s expense - are not typically on the table. Furthermore - most occupants - who have vacated - are not interested in investing to re-furbish the interior. Therefore - a sad, worn out building greets prospective occupants. Not terribly inviting.

Credit of the occupant. An owner with an Amazon lease will not be terribly interested in accepting anything less. Why should he? He has Amazon on the hook. If Amazon has decided the unit no longer meets their needs and vacates - the owner can be quite selective in backfilling.

An above market rent. Any lease in SoCal originated after 2015 will most likely be above the going rate today. So grouped with your amazing credit, a short term lease, an uncooperative owner, and an unwillingness on your part to paint and carpet - you could be stuck. So what’s the answer? Conduct a fire sale of sorts. Take a look at what you owe and figure 75% of that amount. Now market your sublease at that reduced rate. You might just find that unicorn willing to transact.

Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.com.

The Yin and Yang of Commercial Real Estate Subleases

Subleases. I avoid them at all costs. Why? Because subleases are generally unfavorable to the original tenant (sub-landlord) and landlord (master landlord), risky, and complicated. Sometimes, however, a sublease cannot be avoided and in isolated cases some benefits inure to the parties. What follows is a review of the ups and downs of a commercial real estate sublease.

What is a Sublease? When a tenant must relieve himself of a lease obligation prior to the expiration of the lease, the need to sublease occurs. The lease of commercial real estate has a landlord and a tenant. The two parties agree to a term (commencement and expiration), an amount of rent to be paid monthly, any annual increases in the amount of monthly rent over the term, and any concessions - abated rent, building improvements, and pre-possession clean up. The points are memorialized into a lease agreement and both parties sign. Every effort is made by the tenant to live up to the terms of the lease. Occasionally, the tenant finds himself unable to fulfill the lease obligation - outgrows the building and must move, is acquired by a competitor and finds the space is redundant, or the sales of the business no longer support the rent payments - just to name a few examples. In a sublease arrangement, the landlord becomes the master landlord and the tenant becomes the sub-landlord. The new occupant is referred to as a sub-tenant. Confusing, huh?

A sublease is unfavorable to the tenant. The tenant is committed to the landlord for an amount of rent over a period of time and very few landlords would let the tenant walk without a hefty penalty. A sublease is akin to a "fire sale" - the lease is no longer needed or wanted - and thus must be liquidated. The tenant (now the sub-landlord) is desperate to get rid of the excess space but has very little leverage with which to negotiate. Additionally, if a sub-tenant is located, and a deal struck, the original tenant is still on the hook if the sub-tenant does not play nicely - fails to pay rent. Another unfavorable factor is the term remaining on the lease. Most prospective tenants seek a three to seven year lease term. If the term of the sublease has fewer than three years remaining, the sublease has less appeal to prospective tenants in the market. Occasionally, a landlord will capitalize on the shortened term, realize the term is less marketable, and use the tenant's desire to liquidate as a means to secure a new tenant.

A sublease is unfavorable to the landlord. A layer of risk and complexity is added with a sub-tenant. The tenant with whom you negotiated and transacted is now vacating your building. Although the tenant is still obligated for the performance of the lease, another party (sub-tenant) is now your occupant. To a certain extent, your original tenant's faithful rent performance is dependent upon the sub-tenant - sub-tenant pays the tenant and the tenant pays you. Frequently, if the remaining lease term is fewer than three years, a prospective sub-tenant may want a longer term. You now must commence negotiations several years sooner than you anticipated. You must now decide - well before the old lease expires - what your attitude is on a longer term.

A sublease is risky for the sub-tenant. Subleases are generally taken "as is - where is". Remember, the sub-landlord (tenant) is out and consequently doesn't want to spend any money refurbishing the space. The normal concession package of abated rent, building improvements and clean up are rare with a sublease. You may be asked to vacate at the end of the sublease term because you will not have any options to extend or any renewal rights. What happens if the sub-landlord (tenant) fails to pay rent? Your position is compromised - or worse - you get evicted!

Sometimes benefits occur. Subleases appeal to new companies with little or no credit history. A sub-landlord (tenant) is less concerned with credit - after all the sub-landlord (tenant) is still obligated. Subleases are advantageous for fast growing companies. Because a shorter term remains with a sublease, a fast growing company has the flexibility afforded with a shorter term - they are not committing to a long term obligation. As revenue and employee growth are uncertain for these companies, the shorter term works. Sometimes, the market rate for new leases is greater than the rate for a sublease - a sub-tenant can save money. On the flip side, a sub-landlord (tenant) can make money. Just make sure your agreement allows you to reap any profits taken from a sublease.