White paper subleasing office space


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White paper subleasing office space

  1. 1. A Client Guide to Subleasing Office Space colliers international | baltimore www.colliers.com/greaterbaltimore
  2. 2. colliers international | Baltimore | p. 2A Client Guide to SubLeasing Office Space Introduction For a variety of reasons, organizations large and small occasionally encounter the need to sublease space. However, all too frequently this exercise is done without a fundamental understanding of the difference between the sublet and let / relet process. It is the purpose of this white paper to better educate firms having the need to sublet space as to what they should expect and why. Robert A. Manekin sior Managing Director & Principal | Baltimore Bob Manekin, author of this white paper on A Client Guide to Subleasing Office Space, is an industry veteran with 37 years’ experience in tenant representation, general brokerage, development, property management and consulting. A former attorney, Bob heads Colliers’ Baltimore Law Firm Practice Group and has represented a significant number of Baltimore law firms. Bob also has extensive experience working for health care organizations (Mercy, Sinai, St. Agnes) and major companies like CIGNA, FedEx, UPS and First Data. He is currently an adjunct faculty member at Hopkins Carey Business School and has lectured on real estate topics at MIT, UNC’s Kenan Flagler School of Business, Maryland Continuing Legal Education (MICPEL), and numerous trade & industry groups. Overview of Subleasing Organizations sublease space for a variety of reasons. These reasons typically include the following: 1. Excess capacity. 2. Functionally obsolete premises. 3. Non-compliant (from a user perspective) facilities (e.g. access, life safety, technology). 4. E-work opportunities reducing the need for leased square footage. Irrespective of the reasons for subleasing space, a process is initiated requiring a different approach than typically encountered in the leasing of space. The fundamental difference in this approach is the fact that subleasing space is all about minimizing losses as opposed to maximizing returns or cash flow. Stated another way, the organization subleasing excess capacity should not expect to make money on the transaction. The goal should be minimizing loss as opposed to maximizing gain.
  3. 3. colliers international | Baltimore | p. 3A Client Guide to SubLeasing Office Space Understanding Sublet Space In analyzing space to sublease, the following factors should be considered: 1. The Amount of Space to Sublet • How much space is to be sublet? • What is the average transaction size in the market? • How many competitive blocks of similarly sized space exist? • What is the absorption of those sized units in the marketplace? Once all of these questions have been asked and answered, the user will have a better understanding as to how long it should reasonably take to lease the space. 2. Configuration • How is the space configured? • What is the utility of the layout? • Is it primarily offices or substantially open space? The configuration of the space will also determine how easy (or difficult) it will be to lease. For example, a medical office space consisting of nothing but private consulting offices and/or exam rooms will be extremely difficult to sublease, to a non-medical user, as most office space users seek a balance between private offices and public workspace. Accordingly, subleasing medical (or specialty) space will take longer than space with a better balance of private offices and workstation areas. 3. What To Do With Furniture, Fixtures and Equipment In certain circumstances, the configuration of the space may be enhanced by leaving the furniture and fixtures in place. In this manner, a prospective user will not have to incur the additional costs and lead times associated with obtaining new and/or used furniture for this requirement. Consideration should be given – and value should be sought – for subleasing space complete with furniture for both private offices and workstation areas if that represents a competitive advantage. 4. Length of the Term There is a traditional “predisposition” to find a subtenant whose term needs coincide with the term of the prime lease. However, this is not always possible. Accordingly, in marketing the space, the minimum term acceptable should be understood, realistic and consistent with the market. In certain circumstances, a landlord may be prepared to offer a longer term to a creditworthy subtenant, thereby creating an opportunity for the current user to eliminate all liability. In other cases, more term remains on the prime lease than available elsewhere in the market. Do not let term dictate whether a transaction occurs. 5. Rent Sublet space should be priced to move! The longer it takes to sublease, the more expense is incurred and the less the percentage of recovery. In most markets today, it is virtually impossible to make money on a sublease transaction. So do not even try. To repeat a theme, the goal of subletting is to move the excess space to minimize loss, not maximize potential (and actually illusory) gain. To that end, a rental structure should be developed which provides the marketplace an incentive for taking the space. 6. Improvements In the real world, sublet space does not usually offer 100% of what the new user requires. Accordingly, money is usually needed for recarpeting, repainting, some construction work, etc. Many firms subleasing space prefer to grant free rent as opposed to providing cash for improvements. Irrespective of the approach taken, one thing is certain – firms subleasing excess space need to be prepared to address the concept of providing monies for improvements to the space if they expect to successfully sublet the space.
  4. 4. colliers international | Baltimore | p. 4A Client Guide to SubLeasing Office Space Marketing Sublet Space Sublet space is traditionally marketed pursuant to the following strengths: 1. A rent lower than rent for comparable space. 2. Greater opportunity for flexible or shorter lease terms. 3. Ability to take quick occupancy, as furniture, fixtures, equipment and technology infrastructure sometimes come with the space. Those are the strengths in the traditional marketing of sublet space. However, there are clearly weaknesses, which typically include the following: 1. In bad economic times substantial amounts of competing sublet space exists. 2. The need to engage in substantial retrofit for a perspective user often occurs. 3. A lease term shorter than the prime lease, therefore creating a gap. The existence of strengths and weaknesses will clearly be a function of the economy at the time, as well as supply and demand in the marketplace. In that regard the existence (or lack thereof) of additional space in the subject building is also an issue, and could drive the success (or failure) of the sublease effort. Strategies to Consider In marketing sublet space, a strategy should be developed for leasing the space as quickly as possible. Such a strategy would include, at a minimum, the following: 1. A rental rate geared to get attention and move the space (typically at least 15% below market). 2. A decision as to how much tenant improvements will be funded and how (cash or free rent). 3. A set of pre-approved parameters, thereby facilitating the review / approval process. 4. A utilization of the sublessor’s other operating units, its customers and strategic partners to determine what, if any, use they may have for the space. 5. A determination as to whether the space should be sublet in its entirety or marketed for less square footage, or on a per capita utilization basis. (In certain circumstances, sublets have taken the form of a license agreement, whereby a user pays on a per head basis and shares certain common facilities – e.g. rest rooms, conference rooms, coffee stations, etc.)
  5. 5. colliers international | Baltimore | p. 5A Client Guide to SubLeasing Office Space Economics of Subleasing Space As has been stated and reiterated above, in subleasing space, it’s not a function of how much you will make, it is how little you hope to lose. Financial modeling will demonstrate that the longer the space remains unleased, the lower the rental rate at which the space could have been marketed or leased. Accordingly, the focus should be on minimizing losses. As a real estate rule of thumb, any transaction in which the company subleasing space can recapture fifty cents on its rental dollar is a good transaction and should be taken. Furthermore, it needs to be remembered that there is more than rent at stake – tenant improvement allowances, commissions, and marketing expenses are also involved. Key Issues to Consider 1. Creditworthiness of Sublessee As a general rule, Fortune 500 companies seeking to sublease space are usually more creditworthy than virtually all other prospective sublessees in the market. Accordingly, landlords are extremely reluctant to trade the tenant’s creditworthiness for a subtenant’s creditworthiness. However, if a proposed subtenant is a creditworthy publicly traded company, the landlord should be willing to either approve the sublease or deal direct. Under certain circumstances, a direct one-time payment to the landlord to accept the sublessee for a new prime tenant is worth it. 2. Landlord Reviews of Transactions In developing the strategy to sublease space, the sublease review process in the prime lease should be closely analyzed. Landlords have a variety of rights with regard to review and approval of subleases. One of the rights is taking the space back and dealing directly with the sublessee. Another is merely having a certain period of time in which to review the transaction. It is necessary to understand the landlord’s review rights in developing the marketing strategy so that everything can be done to expedite the review process. Delays kill deals, and landlord reviews of prospective subleases fall within that category. 3. The Sublease Document When the decision has been made to sublease space, the form sublease to be used should be prepared, reviewed and forwarded to the landlord for his review in advance. In this manner, once a transaction has been identified, the time associated with landlord review can be significantly reduced. 4. Timing on Sublease Once the decision has been made to sublease space, the space should be vacated and prepared for marketing as if prospects were walking through the next day. There is nothing more frustrating than marketing space not knowing exactly when it is available. A delivery date should be known internally and communicated to the marketplace as to the date on which the space will be available. The perspective that “I can move out when someone needs to move in” impedes the effective subleasing of the space, makes the subleasing process more difficult, and jeopardizes a speedy disposition.