The Pros And Cons Of Commercial Subleasing (+ VIDEO)
Early indicators of Q2 2020 sublease stock in the Australian capital city market suggest that, on top of the already record-high vacancy rate, office space available for sublease will surpass the 90,000 sqm of sublease stock that was available in Sydney and Melbourne post-GFC.
Subletting all or part of your premises to another company can aid cash flow and reduce rental payments in this time of flux. But it’s important to understand your rights and responsibilities when it comes to commercial subleasing – both as the Sublessee and as the Sublessor.
In the above video, Tim touched on some of the benefits of commercial subleasing for sublessees. We delve a little deeper into the topic to ensure both parties understand the pros and cons of entering into a subleasing arrangement.
What is commercial subleasing?
A commercial sublease is a stand-alone agreement between a tenant who already holds a lease to a commercial property (sublessor) and another party who wants to occupy part or all of that commercial property (sublessee).
There are a few reasons why a business may choose to sublet their premises including to reduce cost, optimise space or to consolidate sites.
The advantages of commercial subleasing
There are many benefits that come with commercial subleasing, particularly post-COVID where many businesses are feeling the pinch.
1. Lower cost
One of the biggest benefits to commercial subleasing is the cost.
The rent attached to subleases is almost always substantially less than a direct lease. If your business only requires a small amount of space, it can be difficult to find a property at a reasonable price. With commercial subleasing, you have a better chance of only paying for what you need.
What’s more, most subleased spaces come fully fitted out, so you will not have to worry about upgrades and fit-outs.
Whether you are liable for the cost of ‘making good’ at the end of the term will come down to negotiation. Some subleasing agreements will require you to make good as per the obligations of the overarching lease. This is because the sublessor will argue that they no longer have direct control over the space that you are subletting.
For sublessors, subletting can be a short-term strategy to reduce costs and increase cash flow, particularly post-covid. And there are a few reasons a business may choose to do so:
- Tough climate – if the business is suffering or the future is uncertain, it may make sense to lease out part of a commercial space to save on rent and get cash flowing back into the business.
- Downsizing and leaner workforces – The average company needs 20% less space today than they did pre-COVID. And this potential space-saving can really improve a business’s bottom line. So many companies may be actively choosing to sublet extra space instead of relocating.
- Closing down – The current economic conditions are forcing some companies to consider closing up shop. In this instance, signing up a short-term subtenant with the view of eventually assigning the lease over to them can help circumvent the costs of exiting a lease.
Despite this, we are advising clients to expect to recover less than 50% of the rent paid under the Head Lease when subleasing space to a sublessee. The proliferation of office vacancies and sublease stock on the market has had a very fast effect on the value of sublease rents achievable.
This is a benefit enjoyed by sublessees. In Australia, a landlord will generally expect you to commit to a minimum term of three years with the option to extend.
Most subleases, on the other hand, tend to be within the six-to-24 month range, so they are great for businesses that are looking for short lease terms. This is because the sublessor will already be part way through their lease. So, your sublease may only be for the remaining portion.
Subleasing also keeps things flexible for companies in volatile industries, or for companies who are unsure of the future post-COVID. This is because a sublease affords sublessees the opportunity to upsize or downsize at the drop of a hat.
3. Networking opportunities
For both sublessors and sublessees, subleasing part of a commercial space with a complimentary business can create opportunities to network; generating new ideas and growing referral bases with other similar but non-competing companies.
The ideal situation is to sublease from, or sublet to, a company who works in the same industry, but provides different services. This greatly increases the opportunities for cross-promotion and share referrals. What’s more, subleased space is not private space, which means you’ll be in an environment with another business’ signage and advertising. So, teaming up with similar professions might disseminate that ‘small business’ feel when your clients visit.
4. Fewer strings attached
For sublessees, subleases are far less complicated than other types of commercial leases. However, it’s important to note that a sublease is a legally binding contract that is based on the original lease. So, ensure you carefully review the terms of both the sublease and the original lease to minimise your risks.
It’s best to consult a tenant representation specialist or lawyer before signing, and stay wary of sublessors who refuse to show you their original leasing documents.
5. Shared amenities and facilities
Subleased spaces are usually part of larger areas. So, sublessees may not have to pay for (or may share the cost of) utilities, like the internet, air-conditioning and alarms. You may also be able to negotiate access to the sublessor’s photocopying machines or other office equipment, which means less for you to purchase.
Many subleased properties also provide access to shared areas such as bathrooms, storage rooms, meeting rooms etc. at a reduced cost or, if you’re lucky, free of charge!
Although unlikely in a post-COVID market, when drawing up a subleasing agreement, there is an opportunity for sublessors to negotiate to share the cost of utilities with the sublessee. This means more cash can be pumped back into the business.
6. No unpredictable costs
Another benefit enjoyed by sublessees.
Subleases are usually fully-serviced leases with flat payments and no unpredictable outgoings.
Of course, as the sublessee, you will be responsible for the cost of any damages you cause. However, your sublessor and the landlord will be responsible for other building costs, such as repairing and maintaining common areas.
The cons of subleasing for sublessees
There aren’t too many risks when it comes to commercial subleasing. But, as with everything, there are some. If you’re considering a commercial sublease, keep the following things in mind.
1. Risk of sublessor default
Perhaps the most significant risk that you need to consider is the chance of your sublessor defaulting or breaching the terms of the original lease. If this happens, a sublessee will likely lose immediate access to the premises.
This point is particularly important to consider in the current climate.
You can mitigate your risks by ensuring your sublease terms include the rights to recover costs and damages. Be sure to understand your rights and obligations when it comes to sublessor default, make sure your sublease rent is finding its way to the Landlord’s pocket, and make sure you’re protected before you sign on the dotted line.
2. Unfavourable lease terms
If the sublessor has negotiated less than favourable terms with their landlord, they may try and pass these on to you. So, be sure to ask to see their original contract, and do your research by comparing your terms to other properties on the market.
This is another situation where tenant representation and/or legal advice can go a long way.
3. Less flexibility to customise
Often, subleasing means that you share a space with an existing tenant. This can help reduce costs because the fit out is already done, but may mean you have less room to move when it comes to personalising your space to suit your brand and business needs.
If you have very specific requirements for how you need your space set up, you may need to consider your own commercial lease. Another way to avoid problems is to seek very clear agreement from your sublessor regarding the control you have over the space. Keep in mind that you may also need approval from the building owner (on top of your sublessor) to make changes.
4. Maintenance Delays
If you require landlord maintenance and repairs, you may have to raise the alert through your sublessor, which can cause delays and headaches.
The cons of subleasing for sublessors
Subletting isn’t the perfect solution for all businesses. In fact, post-COVID we are generally advising our clients against subleasing extra space.
Nonetheless, if you are thinking about it, do consider the following:
1.Finding a tenant
If you’re in a location that has a limited amount of retail or commercial space available, it may be hard to find a high-quality tenant, let alone one that’s only after a short-term arrangement. This may not be a huge issue post-COVID, but it is worth mentioning.
Some leases will also prohibit subletting to:
- companies that are already in the building
- companies that are in similar industries to those already in the building
So, be sure to understand the requirements before advertising your vacant space.
It’s also worth noting that most commercial leases require landlord approval of the sublessee. Sublessors may even have to pay a fee for this process. So, it’s essential to ensure that you find a tenant that your landlord will be happy to approve.
As the original lessee, you will still be 100% responsible for the rent and any other obligations under the original commercial leasing agreement.
That means that if the sublessee defaults (i.e. they stop paying rent or cause damage to the premises), then you remain liable to the landlord.
3. Rental reliance
If the subletting agreement is crucial for you to be able to make rental payments, then this type of arrangement can be highly risky. That’s because the sublessee can vacate the premises at any time, leaving you to foot the whole bill.
4. Recuperation of costs
If a business has excess space, trying to sublease it out will only recuperate less than 50% of the rent they’re paying. So, it’s not always the answer to their prayers. In fact, with damages clauses in the sublease that favour the sublessee, defaulting under a lease with a sublease in place will leave the potential for greater damages than a company had before.
Looking to sublease?
It’s simply not the only option for exiting unwanted or excess space. Subleasing is a short term band-aid that needs to form part of a detailed property strategy.
Tenant CS represents tenants, not property owners. We are independent and conflict-free and can help you develop a sublease property strategy.
Ask us today how we can assist you!