September 23, 2020
Has Covid-19 forced your company to rethink the office environment, but you still don’t understand your long-term needs? Maybe you still need space, but you need to move into a new space that allows for more social distancing for employees? Are you growing faster than your current space or building can accommodate? Maybe you are being relocated by your Landlord and are not satisfied with the relocation space? Whatever the case may be, subleases can create opportunities for tenants looking for offices that are available quickly, may be move-in ready, or may be able to accommodate a short-term need. With more and more sublease office spaces hitting the market, you may want to take the following into consideration when looking at a sublease:
What is negotiable in a sublease deal?
It is important that as the Subtenant, you conduct a careful review of the Master Lease and fully understand the terms that you will be inheriting. In most scenarios, the majority of negotiating by the Subtenant will be on economically related items. Rental rate, escalation, and abated rent are the three main economic factors that tend to be the focus. The length of term can also be negotiated, though depending on the length of term left on the Master Lease and the market conditions at the time, many Sublandlords look for Subtenants that can commit to the space for the remainder of their term. Furniture and tenant improvements can also be negotiable items though some Sublandlords may not be willing or able to provide cash out of pocket for Subtenant’s improvements. [This is more so the case in today’s environment than ever before as businesses are trying to preserve cash.] Also, rights that have been granted to the Sublandlord that extend beyond the Lease Expiration Date do not automatically transfer to the Subtenant. A common example would be an Option to Renew. The Subtenant would need to negotiate a new, direct deal with the Master Landlord if they desire to remain in the space beyond the expiration of the Master Lease.
The Master Landlord must give their consent.
Even if a Sublandlord and Subtenant come to terms on a deal, the transaction will not be fully binding or able to commence until the Master Landlord has reviewed the prospective Subtenant’s financial documents, commencement date, use, and reviewed the Sublease document itself. Covid-19 has Master Landlords and their lenders taking deeper dives into Subtenant financials. Some Master Lease language will require that the Subtenant have similar or better credit than the Sublandlord. This is something that you as the prospective Subtenant will want to vet early in the process to ensure you are not wasting your time.
The Master Lease will also dictate the required timeline for the Master Landlord to give written consent. Furthermore, the Master Lease will often include language allowing for the Master Landlord’s “recapture” of the space in the event of a proposed Sublease. Several scenarios can drive a Master Landlord to do this, the two main reasons being 1) To accommodate a large tenant within the building that needs to expand, and 2) When the Sublandlord is paying below market, creating an opportunity for the landlord to profit from re-letting the space at a higher rental rate.
The Master Lease Rules!
The final terms between the Sublandlord and the Subtenant are going to be subject to the terms and conditions outlined in the agreement between the Master Landlord and Sublandlord. The Master Lease will dictate many non-economic factors like the Master Landlord’s Option to Terminate or their ability to relocate. If you have to make changes to the space for it to work for your business, the Master Lease will dictate what alterations can be made to the space and approval process for the alterations – certainly something you will want to vet early in the process. Language surrounding sublease profits is also addressed in the Master Lease and how they are handled. Often the Sublandlord must split sublease profits with the Landlord after deducting reasonable expenses, such as marketing costs and brokerage commissions
Document the condition of the space and its contents.
It is important to do your due diligence on the front end of the transaction to ensure avoiding a headache on the back end. If the use of the Sublandlord’s furniture, technology, or equipment is part of the deal, make sure it is properly inventoried so there is no question of who owns what. Taking photos or video of furniture to document its condition is recommended. Furniture can be very expensive to disassemble and move so make sure that the Sublease clearly states responsibilities at the end of the term. If the Master Landlord requires the Sublandlord to restore the suite to its original condition prior to surrendering the space, then this must be addressed within the Sublease Agreement or the Subtenant could be left with that cost upon expiration.
These are just the basics. Subleases can be very advantageous to fulfill a business need and are a flexible solution in our everchanging environment. However, they can also be more complicated than a direct transaction. For that reason, it is all the more important to have an experienced Tenant Rep broker who is familiar with the ins and outs of negotiating subleases on your behalf and helping you through the process.