Magazine article Journal of Property Management

So Your Tenant Wants to Sublease?

Magazine article Journal of Property Management

So Your Tenant Wants to Sublease?

Article excerpt

The telephone rings its final call on a rainy Friday afternoon. It's your tenant, telling you he wants to sublease 10,000 square feet of office space. You mentally reach for a large bottle of aspirin, anticipating an administrative headache.

Real estate giants from CB Richard Ellis Services, AMO to Cushman & Wakefield report rising vacancy rates as a national trend. The dot-com bust has sent sublease markets soaring. The California Silicon Valley Business Times says, "a second wave is pounding the office market.. more established companies are dumping grandiose expansion plans.. Others are swooping in for good deals-and moving into fully stocked offices. All you have to bring is your coffee cup,' quipped San Jose, CA broker Mark Ritchie."

Sublease or Assignment?

Subleases and assignments are oft-misunderstood creatures. The Commercial Lease Law Insider, an industry publication, defines assignment as a transfer of a tenant's entire remaining lease term. An assignment transfers a tenant's entire interest in the lease (square feet, term, rent, etc.). With assignment, the landlord can look directly to the assignee to comply with the terms of the lease. The assignor may, or may not, be released from liability. If not, then there has been a credit enhancement, to the extent of the assignee's credit, because both assignor and assignee have responsibility for any lease default.

A sublease transfers less than the entire term and interest in a lease. In general, a subtenant has no legal relationship with the landlord. The sublessor retains responsibility for the lease and its obligations. The landlord can only pursue the sublessor (absent any other agreement that allows sublease rents to be paid the landlord if the sublessor defaults) for past due rent or for any other default. Likewise, the sublessee does not have direct rights against the landlord but rather must look to its sublessor for resolution of any issues.

The resulting relationships mimic a large extended family. Think of a triangular dinner table with landlord, sublessor (tenant) and sublessee (subtenant) seated on each side. They're accompanied by their respective brokers, attorneys and representatives, which can make for chaotic gatherings. (Note: Sublease is the situation most commonly encountered by real estate professionals, and for the purposes of this article the subsequent terms "sublease", 11 sublessor" and "subtenant" refer to both sublease and assignment.)

Landlord's Outlook

In a sublease scenario, the landlord generally experiences several possibilities. First, the tenant may hire his own broker and sublease the space. Second, the landlord may recapture all or part of the space and release it to another company. Third, the landlord may negotiate a lease termination with the existing company and then release the space. Clearly, the second and third options pose risks if the landlord recaptures space on a speculative basis. Unless there's a compelling reason-such as a pending tenant bankruptcy or a substitute tenant in the wings-- landlords generally do not assume speculative space.

Landlords often prefer to keep their tenant "on the hook", and let the tenant assume inherent leasing risks of competition, tenant improvement and leasing commissions, etc. Sublease markets are more densely populated with start-up firms, smaller companies, and those reluctant to make long-term lease commitments. Generally these companies pose higher credit risks.

Landlords can benefit from what brokers term "incubator" space. Landlords get to know subleasing companies as building occupants, but without a formal agreement. Each can evaluate if they'd like to pursue a direct relationship at the close of the sublease term.

Most leases allow for the landlord to share in all or part of the sublease profits, in order to discourage tenants from competing with them in the real estate business. Actual profit, proves the exception rather than the rule. …

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