Subleasing: New Life For an Old Lease? Not!

notConsider the following scenario: a fast-growing Internet retailer has grown to the point where outsourcing their warehousing is the next logical step. But what options do they have when it comes to their existing distribution center leases? None of them are very good. Fortunately, there are a number of realistic alternatives, including subleasing.

The Rulers of the Tiny(er) Realm

Not terribly long ago, the mantra “bigger is better” was widely known and accepted. But people today are beginning to wake up to the fact that when it comes to operating a business and remaining profitable, “smaller is smarter.”

For example, Accenture subleased 123,000 square feet in a project where my firm, Cardinal Real Estate Partners, represented the landlord. When they first moved in, that space was filled with 546 mortgage processors. That’s one person for every 225 square feet. Today, there are 953 people in the same space, or one person for every 125 square feet. The result is that the demand for office space is changing and the total market of office space that is being subleased has increased substantially over the past 3 years.

Today there are more people in less space in the US. Meanwhile, in the instance of the Accenture example above, somewhere in India there’s a landlord asking, “Hey? Where did everyone go?”

Warning: if the thought of only recapturing 50 percent of your lease exposure through subleasing gives you heart palpitations, stop reading now. The fact is, the costs will add up. However, perhaps you have highly marketable space where the pain of subleasing is not so high.

Here are some tips and suggestions that can help you out:

  • Get a good understanding of the competitive landscape. You can do this yourself, but it’s strongly suggested that you engage a professional real estate broker. Without that accurate information at your fingertips, you won’t have the ammunition necessary to deal with subtenants who feel they’re entitled to 10 to 60 percent discounts in rent.
  • Consult with your accountant and your attorney. You’ll want to get your accountant involved to handle the complex expenses associated with subleasing. In order to sublease, you’re going to have to pay brokerage commissions, marketing costs, preparation of the premises, rent and concessions, property improvements, and legal costs. Also, bear in mind that the delta between what you’re paying for your lease and whatever deal you’ve negotiated with your subtenant has complex profit and loss considerations attached to it. Note that your depreciation calculations will be impacted, since the FF&E that you’ve invested into the space are likely to have very little value to your subtenant.
  • Do you believe in karma? Maybe you should start. Now that you’re the sub-landlord, get ready to receive payback for any heartache you caused landlords in the past. Your subtenant will be late with rent, have unreasonable demands and a knack for causing havoc. To minimize this, be sure that you understand all subleasing and assignment clauses in your lease. The ideal situation is the latter – the assignment – because it effectively lets you assign all about your obligations under the lease. Except, of course, in the instance where the tenant is in default – you didn’t think you could really just walk away, did you? In most cases, you’re going to have to settle for being in less-than-optimal position of being a sub-landlord to a subtenant. When that’s the case, get ready to answer phone calls about broken toilet mains and to wait out the tardy rent payment. Or much, much worse.

As scary as it all sounds, the benefits of subleasing are obvious. By doing so, you put yourself in the position of reducing operating expenses and enhancing cash flow. But just like anything else, there are strings attached. And sometimes, those strings can tangle you up. Don’t get tangled up. Get educated and get yourself prepared. Then go in and nail it.

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