The sublease alternative Featured

8:00pm EDT September 25, 2009

Just a few short years ago, life as a commercial office building owner was good. Rates were at all-time highs, vacancies were at all-time lows, and office buildings were trading left and right at unheard of prices.

Fast-forward to the present, and the reality is a little gloomier.

“The office space market is experiencing negative absorption and rental rates are sliding,” says Trey Miller, a leasing advisor with Moody Rambin Interests. “Both lead to one of the most talked about words in office brokerage these days: the sublease.”

Subleasing, the act of an existing tenant leasing all or part of its space to another tenant, has become increasingly popular as the overall economy slows. When businesses are laying off employees in large numbers and otherwise trying to decrease operating costs, scaling back office space is a very sensible move. However, planning your strategy is the hard part, and if you don’t have the right mindset going in (and the right broker) you’re going to waste a lot of money.

Smart Business spoke with Miller about subleases and how to use one to your advantage.

Why are subleases attractive to the subtenant?

Typically, subtenants should expect at least a 25 percent discount compared to direct space since they’re offered the space as-is, i.e. there are usually no build-out dollars available, and the lease term is normally shorter than a direct lease term. And with more and more sublease space coming online almost daily, the increasingly strong buyer’s market is only gaining steam. Consequently, a company shopping for lease space should have landlords (and sublandlords) fighting for its deal. Furthermore, if your company is searching for a ‘plug and play’ solution, it is not difficult to find. Plenty of ‘A’ buildings have sublease space available with quality build-out (including furniture, telephone systems, etc.) offered at a substantial discount.

What benefits can the sublandlord see?

The principal notion when dealing with a sublease is ‘cutting your losses.’ If marketed properly, a sublease can help a tenant cut its real estate excesses quickly and recoup as much money as possible. Be prepared to take a financial hit vis a vis your overall liability, but, depending on the remaining term on your lease, you’ll see a long-term benefit when that extra space is off the books.

How does the subleasing process work contractually?

The key to subleasing — for both the sublessor and the subtenant — is credit. Logic dictates that the sublessor should be concerned with the credit of the subtenant, and that’s true. Often, the sublessor is generally much too eager to find a willing subtenant to scrutinize that company’s credit. It is equally important for a subtenant to look at the credit of the sublessor. It’s a three-party agreement, but there is no privity of contract between the subtenant and the master landlord. As a result, a subtenant has to make sure that the sublessor is reliable, and will not default under the master lease. To protect against that possibility, a subtenant should request to pay the master landlord directly (in addition to maintaining the right to cure any default by the sublessor).

What should the sublessor expect from the subleasing process?

Besides credit, the next biggest issue to a potential sublessor is expectations. Again, remember that you’re cutting losses, not trying to turn a profit. It’s easy to have sticker shock if you’re paying, say, $30 per square foot for an office and have someone advise you to market it for $15 per square foot. However, that is the type of upfront conversation that a good broker will have with a client.

Subleasing can be painful, but how painful depends on keeping expectations in check. You have to weigh the economic pros and cons of getting a deal done quickly at a reduced rate versus trying to maximize your rental rate and potentially having the process drag on longer than necessary. Remember that an empty office is like an empty hotel room; every passing day is a missed opportunity to recoup part of your investment. It’s possible that the perfect subtenant will come along and you’ll get $25 per square foot on your $30 per square foot lease, but that’s unlikely. For most, the days of making money off of a sublease are long over, particularly those who signed leases at the height of the market in 2007 and 2008.

Who should a company turn to for assistance when looking to sublease?

You have to find a quality broker who knows your submarket and knows how to make your product stand out from the myriad of options available. In the past, a broker would simply send out an e-mail blast to the brokerage community and wait for the phone to ring. Now that the market is so inundated with space, brokers barely read these e-mails anymore. Believe it or not, better results are achieved by using good old-fashioned ‘snail mail.’ Additionally, sublease listing brokers need to be much more proactive in searching for possible subtenants in the existing building as well as the surrounding submarket. If you’re lucky, there may be an opportunity right under your nose.

Trey Miller is a leasing advisor with Moody Rambin Interests. Reach him at (713) 773-5584 or TMiller@moodyrambinint.com.