Start-Ups and Emerging Companies Should Evaluate Office Subleases

by CoyDavidson on March 19, 2010

Recent economic conditions have forced many companies to put unused office space on the market for sublease. The amount of sublease space available in most major markets around the country is significant. While subleasing office space does have some inherent disadvantages in many cases the benefits of subleasing office space for start-ups and emerging companies far outweigh the disadvantages.

The Advantages of Sublease Space

  1. Cash Flow Preservation: The biggest benefit of a sublease is cost. Subleases are almost always going to be a less expensive option than a direct lease with a landlord and in today’s soft market with substantial sublease inventory available the cost savings can be significant. Minimizing your occupancy costs frees up capital for deployment in other key areas of your business.
  2. Flexibility in lease term: Most Landlords prefer a five year lease term and sometimes 3 year terms are achievable. However it is often a difficult decision for a start up to make a longer term lease commitment. Today, with substantial sublease inventory available it is not uncommon to find attractive sublease opportunities with variety of terms of available ranging from 12- 48 months and some cases even longer.
  3. Relaxed scrutiny of creditworthiness and security: One of the challenges for start ups and young companies with a short operating history is the security required by the Landlord in a direct lease. A company with a proven operating history and good credit will only be required to provide one month base rent as a security deposit or in the case of the most credit-worthy tenants no security is required. However, this is rarely the case for start ups. Buildings owners are likely to require personal guarantees, a significant letter of credit to be pledged or as much as one year of rent as security deposit to take the risk on a start up as a tenant. In a sublease situation, the sublessor remains obligated to the Landlord for the lease obligation and in many cases the sublessor, who is motivated to reduce costs is more willing to take a risk on the start- up tenant and the security required is significantly less than what the building owner would demand.

The Disadvantages of Sublease Space

  1. Finding a sublease space built out that exactly fits your needs is not a common occurrence. Typically tenant improvement allowances are not offered by the sublessor, so customizing the space to your exact needs is not possible unless you are willing to pay for those costs.
  2. Since you are not in a direct contractual relationship with the landlord, your rights are tied to the performance of the primary tenant. Should the primary tenant default for financial or other reasons, you will likely be evicted unless you can come to terms quickly on a direct lease with the building owner and you will be subject to the building ownership’s financial and leasing terms.
  3. After the sublease expires you will be subject to market rental rates for a direct lease. If you were in a sublease situation with deeply discounted terms and your company is not ready for a rental obligation at that level you may be forced to move. Moving can be expensive and relocating to a lesser quality building may not be the best situation for employee morale and recruiting new employees.

Identifying Sublease Opportunities

The first step in evaluating sublease options is to retain a qualified real estate professional. A good tenant representative will have knowledge of  the sublease market inventory and the companies that are willing to be the most aggressive to secure a sub-tenant.

Once your basic space requirements have been defined; location, size, layout and desired term, your tenant representative can best match sublease opportunities that most closely fit your space requirement. Once viable sublease opportunities have been identified your tenant representative should assist you in structuring a potential transaction.

Structuring a Sublease

  • Discounted Rental Rates: Of course you want negotiate the rent. Rental rates are most impacted by supply and demand. Companies trying to sublease space would prefer to sublease their space to you at the rate they are paying, but typically have to discount rental rates for a sublease situation to be competitive. In today’s market depending on the specific market conditions this could be as little as 10% but in some cases companies are willing to discount their rental rate as much as 50% to be competitive and mitigate their obligations.
  • Free Rent & other incentives: Just as a Landlord will offer free rent as a leasing incentive so will a sublessor. Again depending on market conditions and the motivation of the sublessor the amount of free offered will vary, but in today’s soft market significant free rent is readily attainable. In addition, if parking charges are part of the lease, the sublessor may be willing to absorb or subsidize a portion of those costs.
  • Furniture and furnishings: Many times when a company chooses to sublease office space that is no longer needed there is also office furniture, equipment and furnishings that are no longer needed as well. I have structured transactions where companies have provided office furniture and equipment at no cost or at deeply discounted values as part of the transaction.

Subleasing office space does have some inherent risk, there are some measures your tenant representative and legal counsel can take to mitigate a portion of that risk in the sublease agreement. For example, a landlord may agree to let the subtenant assume the full rent obligation of a tenant who defaults on rent payments and remain in the space, but obtaining this right with the Landlord is not a given.

Entering into a sublease transaction should be evaluated carefully and who the space is subleased from is very important. Subleasing from a stable company is obviously less risky than a company with significant financial issues. While subleasing is not always the best option, in many cases the economic benefit derived from a well evaluated and structured sublease is the right strategy for the start-up and emerging company.

To receive a complete current list of available sublease options in your market please contact me to discuss your office space needs.

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