Is a Sublease Right for Your Company?

The economic fallout from the current pandemic is fueling uncertainty among businesses of all kinds, and indications have been mounting in the Dallas-Fort Worth commercial real estate market. In April, The Dallas Morning News reported that overall office vacancy in DFW rose to nearly 21 percent. According to CoStar, about five percent of available retail space in the market was listed for sublease in May. And on June 6, CoStar Analytics showed that out of 21.1 million total available square feet of office space in the DFW-MSA, 6.7 million square feet is for sublet. Moreover, both numbers are trending upward. Whether your company needs to re-evaluate space needs because of downsizing and more employees working remotely, or you are a small business owner looking for space at a reduced cost, a sublease may be the answer.

What is a Sublease?

A sublease is when a tenant rents property to a third party (subtenant) for a portion of, all of or in excess of the tenant’s remaining lease contract obligation. This sublease does not absolve the original tenant from obligations listed in the lease agreement, such as monthly rent payments.

Why Might a Tenant Need to Sublease?

Now during the Covid-19 pandemic and even for some time before, tenants requests to sublease or renegotiate leases has been on the upswing. Most often, the reason is that hard times necessitate cutting back. A company that is downsizing may no longer need the leased space. Also, businesses move for a variety of reasons. Contract obligations and lease termination fees may make discontinuing it financially unwise. If the lease permits, therefore, subleasing might make sense in order to cut down on monthly obligations.

Why Shop for Space to Sublease?

There are several potential benefits to subleasing space. First, for a small business or a start-up, a sublease is often more affordable than a direct commercial real estate lease. In some instances, it can provide a flat monthly rent at a below market rate without common area maintenance (CAM) charges and other variable expenses such as property taxes and insurance, which may be the tenant’s responsibility in the master lease. Therefore, budgeting for rent payments may be easier.

Secondly, a sublease is usually for a shorter term. Also, if you require only a small space, or if you’re open to sharing space with a tenant looking to sublease, then you’ll likely find more options in the subleasing market, as well. Finally, most sublease spaces are already finished out and ready for occupancy. Fixtures, furniture and equipment can often be included in the deal, too, or purchased at a steep discount.

What Are the Risks of Subleasing Space?

There are a few risks to subleasing space, too. Consider the following potential drawbacks if you are the sublessee:

• Usually, the underlying lease cannot be changed, so inflexible terms pass on to you
• Review the sublessor’s financials and operations—if they default by not paying the landlord, then it could affect your sublease and you may even be evicted
• Check the permitted uses in the master lease, because there may be limits on how the premises can be used
• The space will probably be leased “as is” so any improvements such as paint or carpet will be your expense
• Make sure adjacent businesses are compatible with yours
• The rent will likely increase after the sublease expires

The sublessor also faces risks when subleasing. For example and as mentioned above, you are ultimately the one responsible for paying rent to the landlord. You may have sublet for the purpose of having a subtenant help cover your rent. If they fail to pay, however, you are still responsible for the full amount.

Similarly, you must return the space to the landlord in its original condition at the end of the lease. The subtenant may be responsible for maintaining the property during occupancy. But if they refuse to make repairs or pay for damages, then these costs will be your responsibility.

Finally, asking a subtenant to make monthly payments that are below your full rent may be the only way to attract a potential sublessee. Nevertheless, be sure to research the local market for comparable building type and class rent rates, so you can negotiate a fair sublease rate.

Despite these drawbacks, a sublease can be advantageous for both parties as long they are careful and perform due diligence. In addition to your commercial real estate broker, it is advisable to have an attorney review the sublease and the original master lease on your behalf before you sign.

 

The information contained in this article is general in nature and should not be construed as financial, tax or legal advice.  As with any financial or legal matter, consult your tax advisor and legal counsel.