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Report: Subleasing can offer advantages

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With primary tenants shedding space as the recession continues, there can be tremendous advantages for those opting to sublease space, but a Jones Lang LaSalle report warned of many pitfalls.

Scot Ginsburg, a JLL executive vice president who wrote the document, said sublease space may be the way to go for a start-up company, companies with little operating history, or companies looking to lease space for a short term.

"Tenants who shed excess office space usually offer it at below market rents, include furniture, and tend to be less stringent on credit worthiness than building owners," Ginsburg wrote.

What happens if the primary tenant also known as the sublandlord, defaults? Ginsburg said in all likelihood, the primary landlord would do one of three things.

One option would allow the subtenant to stay in the space on a month-to-month basis until the landlord finds a new tenant to pay a higher rate. A second option allows the subtenant to stay as a direct tenant in the space with a new lease at a higher rate, and a third option is to simply terminate the sublease forcing the subtenant out of the building.

Ginsburg said that while direct tenants typically have renewal and expansion rights, landlords have proven generally unwilling to transfer these rights to a subtenant.

Subtenants aren't completely powerless, particularly if they have a record of strong performance.

"Subtenants who have a solid operating history may have enough leverage to obtain a recognition agreement from the landlord, the JLL report stated. "This is an agreement between the subtenant and the landlord. Under this agreement, the landlord will recognize the subtenant and its rights under the sublease should the tenant default on its lease obligation."

In the event of a tenant departure, a lease may be entirely transferred from the original tenant to the subtenant.

"A landlord is usually agreeable to an assignment with a subtenant who has an equal or greater net worth than the original tenant," Ginsburg said.

While landlords will often supply tenant improvements at their cost, subtenants normally contribute all the funds to improve or modify the space. This can represent an enormous risk if the primary tenant fails to perform.

The key here, Ginsburg said, is to ensure a recognition agreement is in place or the sublease term has at least four years remaining, including a financially sound sublandlord.

"There's nothing worse than subleasing space and investing hundreds of thousands of dollars into tenant improvements," Ginsburg warned. "Then a year later, the sublandlord defaults on its lease, leaving the subtenant at mercy of the landlord. Not only can the subtenant be out on the street, they will loose all of the capital invested into the tenant improvements."

Utilities can present another problem. Here again, the subtenant doesn't generally have the same rights as those of the primary tenant, and may in fact have to do battle to ensure the services are provided.

Finally, Ginsburg said before subleasing space, subtenants must make sure the master lease is thoroughly reviewed to understand all terms and conditions.

They must assess the sublandlord's (or primary tenant's) financial condition; evaluate what, if any, tenant improvements are required; and recognize the landlord will have to consent to the sublease, which can take up to 30 days.

As for how much sublease space is available, that depends on the submarket, and it doesn't necessarily follow that the submarket with the most direct vacancy has the most sublease space. For example, JLL reported this month that while South San Diego had a 20.1 percent office vacancy rate, the area had a sublease vacancy of 0.2 percent with just 8,479 square feet of sublease space available -- the least of any county submarket.

The University Towne Center submarket had the most sublease space with 430,479 square feet, but here again, while that submarket posted a 16 percent direct vacancy rate, its sublease vacancy was a comparatively low 5.7 percent.

The Sorrento Mesa/Sorrento Valley/Torrey Pines subarea, which had 204,247 square feet of sublease space available, had a direct office vacancy rate of 12.8 percent and a sublease vacancy of just 1.6 percent.

Carlsbad is another one of those submarkets with a high direct vacancy (21.1 percent) and a low ratio of sublease space -- 190,633 square feet available for a 2.8 percent sublet vacancy rate.

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