Commercial Sublease Agreements: Challenges & Considerations Around Covid
Companies are downsizing. And whether COVID-19 has caused a business to grow, pivot or shrink, the immediate effect of the new-world is that companies are declaring that they will not need as much space going forward.
There are limited options for a tenant with a remaining lease tail who wants to rid themselves of excess space. Typically, they’d follow this process:
- Ask the Landlord to accept a partial surrender.
- Receive a rejection from the Landlord on a partial surrender.
- Write off the cost of the excess space.
- Advertise the space for sublease at a heavily discounted rate to recover something, anything.
Therein lies the opportunity for tenants seeking a new space at discounted rates.
Subleasing on the rise
Unsurprisingly, the commercial agencies, usually the source of market data, are so far withholding the Q4 2020 statistics. Even so, it’s common knowledge that subleasing has surged across Australia’s east coast office markets as companies reassess their current and future needs.
The amount of sublease space available in the Sydney CBD and Melbourne CBD by Q3 2020 had surpassed the amount available (90,000sqm in each Syd. & Melb.) at the peak of the Global Financial Crisis (GFC).
In Sydney, by Q3 2020, the volume of sublease space hit a record high of 157,853sqm. This represented a 90% surge in five months, up from circa 105,701 sqm in June and 82,739 sqm in March. It’s estimated that around two-thirds of this stock is concentrated in prime grade buildings and driven mostly by white-collar professional services, financial services and insurance and technological sectors.
Melbourne’s sublease vacancy has also spiked substantially, from 0.7% total stock at the outset of 2020 to 2.3% (circa 117,200 sqm) in October 2020. Since then, this number has continued to increase, particularly in Q4. Unsurprisingly many companies are waiting for 100% occupancy of offices to be allowed before making a final assessment of space requirements. Accordingly, we expect a further surge of Sublease space around Q3 2021.
This upward trend is not limited to the Eastern seaboard either. In Perth CBD, for example, we saw sublease availability increase by 17,000sqm, reflecting a 59% spike over the five months to August 2020.
In fact, the only Australian market where we have not seen a new sublease market emerge is Adelaide. This is chiefly due to limited new supply and the fact that large corporations do not tend to occupy large spaces in the Adelaide market.
Considerations around subleasing during Covid
When it comes to commercial sublease agreements, both sublessors and sublessees take risks; the most significant being the risk of default:
- Default by the Sublessor: The sublessee would likely lose access to the premises immediately and without warning.
- Default by the Sublessee: The sublessor would lose the contribution to rent they have been receiving.
So, the biggest consideration is the financial security of both parties. In the context of COVID-19, risk of default has magnified due to the threat of business failure, particularly as the government withdraws business support measures.
You can learn more about the pros and cons of commercial subleasing here.
Subleasing still an excellent option
Despite some inherent risks, subleasing remains an excellent option for tenants looking to reduce their office footprint, increase cash flow or secure a plug-and-play space with flexible conditions. But there are some things that both parties should consider.
- The right to sublease – A tenant’s right to sublease comes down to the head commercial leasing agreement. If there is no prohibiting or limiting clause, a tenant does not need the landlord’s permission to draw up a commercial sublease agreement. However, if the contract contains such provisions, the existing tenant requires the landlord’s consent before subleasing all or part of the premises.
- Timing – If you require the landlord’s approval, ensure you get the wheels turning as soon as possible because the process can be lengthy.
- Consider other options – Subleasing is not the only option for tenants looking to exit a lease or unload excess space. It’s best to speak to a tenant representation specialist about your options and the best way to manage a lease exit, particularly if you have less than 12 months remaining on your lease.
- Source a reputable tenant – In particular, ensure that you are satisfied with their financial position and future trajectory to minimise the risk of default.
- Costs – If you require landlord approval, consider the costs of gaining their consent. You’ll also need to think about how other expenses (like rent and levies) will be passed on to the sublessee.
- Consent – Check that the sublessor has gained the landlord’s permission before you sign on the dotted line. This will ensure the sublessor is not breaching the terms of the original lease.
- Notices – Ensure that your subleasing agreement requires the head tenant to pass on all communication relating to the premises.
- Check the fine print – Ask for a copy of the head lease to ensure that the terms of the commercial sublease agreement are in line with the original contract.
Get in touch with Tenant CS
Considering going down this path? It can be a great option for tenants looking for short-term, plug-and-play solutions at discounted rates. But it’s not the only strategy for those looking to get rid of excess space. This is particularly true for those with less than 12 months left on their commercial lease.
In either case, subleasing should form part of a detailed property strategy. And both parties should approach it with an air of caution and seek the help of a real estate professional.
Tenant CS represents tenants, not commercial property owners. We’re fierce negotiations, independent and conflict-free. So, ask us today how we can assist you!