The Pros And Cons Of Commercial Subleasing (+ VIDEO)

May 10, 2022
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Commercial Real Estate

Author

Hamish Mackay
Hamish Mackay
Director

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At the end of Q4 2021, Sydney had approximately 98,800sqm of available sublease space, Melbourne CBD recorded a record high of 190,000sqm, and Brisbane CBD had circa 26,500sqm available. And while some CBD subleasing markets are showing signs of slowing, vacancies tend to remain elevated overall, with many companies offering phenomenal terms to drive income ahead of their lease expiry.

Subletting all or part of your premises to another company can indeed aid cash flow and reduce rental payments in this time of flux. But it's important to understand your rights and responsibilities regarding commercial subleasing - both as the Sublessee and 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 reducing cost, optimising space, or consolidating sites.

The advantages of commercial sub leasing

Many benefits can come with commercial subleasing, particularly in the current market where many businesses are feeling the pinch.

1. Lower cost

One of the most significant benefits of commercial sub leasing is the cost.

For Sublessees

The rent attached to subleases is almost always substantially less than a direct lease. If your business only requires a small amount of space, finding a property at a reasonable price can be challenging. With commercial subleasing, you have a better chance of only paying for what you need.

Most subleased spaces come fully fitted out, so you will not have to worry about upgrades and fit-outs. However, whether you're 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. In this case, the sublessor will argue that they no longer have direct control over your subletting space.

For Sublessors

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, leaner workforces and hybrid working arrangements - The average company needs less space today than they did pre-COVID. So many companies may be actively choosing to sublet instead of relocating. And this potential space-saving can improve a business's bottom line.
  • 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 advise clients to expect to recover less than 50% of the rent paid under the Head Lease when sub leasing space to a sublessee. The proliferation of office vacancies and sublease stock on the market has had a swift effect on the value of sublease rents achievable.

2. Flexibility

In Australia, a traditional landlord will generally expect you to commit to a minimum term of three years with the option to extend. But most subleases tend to fall within the six-to-24 month range, so they are great for businesses looking for short lease terms. That's 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 companies unsure of the future, allowing them to upsize or downsize at the drop of a hat.

3. Networking opportunities

For both sublessors and sublessees, subleasing part of a commercial space alongside a complementary 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 that works in the same industry but provides different services. This increases the opportunities for cross-promotion and sharing referrals. 

Moreover, subleased space is not private, 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.

sublessee and sublessor exchanging business cards

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 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. Stay wary of sublessors who refuse to show you their original leasing documents.

5. Shared amenities and facilities

For Sublessees

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!

For Sublessors

Although unlikely in the current 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 will allow more cash to 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 sub leasing for sublessees

There aren't too many risks for sublessees when commercial subleasing. But, as with everything, there are some. So, 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, particularly in the current climate, is the chance of your sublessor defaulting or breaching the terms of the original lease. A sublessee will likely lose immediate access to the premises if this happens. 

You can mitigate your risks by:

  • Ensuring your sublease terms include the rights to recover costs and damages
  • Understanding your rights and obligations when it comes to sublessor default
  • Ensuring your sublease rent is finding its way to the landlord's pocket
  • Ensuring you're protected before you sign on the dotted line by enlisting the help of a tenant rep.

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. But the good news is that post-covid, businesses offering older sublease opportunities are now edging towards cost recovery. So, you're likely to get a good deal. 

sublessee signing a sub lease agreement with unfavourable commercial terms

3. Less flexibility to customise

Often, sub leasing means that you share a space with an existing tenant. An existing fit-out can reduce costs, but it may mean you have less room to move when personalising your space to suit your brand and business needs.

If you have specific requirements for how you need your space set up, you may need to consider a more traditional leasing arrangement. Another way to avoid problems is to seek an explicit agreement from your sublessor regarding your control over the space. 

Remember 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 because you're adding a third party into the mix.

The cons of subleasing for sublessors

Subletting isn't the perfect solution for all businesses. Post-COVID, we generally advise 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, find a tenant that your landlord will be happy to approve.

sublessees and sublessors sharing a commercial space

2. Responsibility

As the original lessee, you will still be 100% responsible for the rent and other obligations under the original commercial leasing agreement. If the sublessee defaults (i.e. they stop paying rent or cause damage to the premises), you remain liable to the landlord.

3. Rental reliance

If the subletting agreement is crucial for you 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, subleasing will only recuperate less than 50% of the rent. So, it's not always the answer. 

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 even greater damages than a company had before.

Are you looking to sublease?

It's simply not the only option for exiting unwanted or excess space. Sub leasing 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 or explore other avenues.

Ask us today how we can assist you!

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