The COVID 19 pandemic has created great uncertainty in how we will use office space in the future. This mandated work from home experiment has taught us a lot about our abilities to adapt, embrace technology and work remotely relatively effectively. It has also made evident our inherent need to be with other people to collaborate, mentor, socialize, learn and create. With return-to-work plans beginning to materialize for many employers, the “new normal” will also begin to take shape. Some organizations (or departments within companies) may remain in a work from home model, many will embrace a new hybrid work model and others will return to a pre-pandemic use of space. Regardless, it is evident that the office market, as a whole, will be utilizing much less space per employee. The result has been a dramatic increase in space available for sublease. Because tenant lease terms typically range from 3 to 5 years for smaller tenants and 7 to 12 years for larger tenants, only 10 to 15 percent (on average) of leased square footage in a marketplace is expiring in a given year. When a tenant has excess space but multiple years of term remaining on its lease, a landlord usually will not take space back early, making subleasing a necessary option to consider. Whether you are looking to hire a real estate broker to list your excess space for sublease or are interested in leasing a sublease space, it can be a tricky proposition. More often than not, the following factors will have a significant impact on your decision making.
Term – In many leases, renewal options are voided if the primary tenant subleases its space. So, a subtenant has a finite amount of time in the space, with no guarantee of being able to get a new lease at the end of the sublease. Even if a new lease is obtained, it will be “reset to market” which will likely be much higher than the sublease rents that are often significantly discounted. While the shorter lease term may be more attractive to certain users such a start-ups, spin-offs/outs or project-based users, those types of tenants make up a very small subset of tenants looking for space in the market.
Construction – In a direct lease with a building owner, the owner typically provides an allowance to cover most, if not all, of the costs to reconfigure the space for the tenant’s use. In a sublease, the primary tenant is unlikely to invest money back into the space as they are looking to cut costs. As a result, the subtenant will either need to accept the space “as-is” or come out-of-pocket for modifications. Even if the primary tenant is willing to provide an allowance it will likely be minimal given the lack of remaining term to amortize those costs. This is less than ideal for both parties and again limits the kind of users that would accept this scenario.
Lease Risk – A subtenant is subject to the primary lease between the building owner and primary tenant leaving the subtenant with no leverage to negotiate alternative terms. Therefore, the subtenant forgoes desired rights such as renewal, expansion, contraction, early termination or other important lease clauses. Technically, a building owner does not need to recognize the subtenant as the owner’s primary relationship is with the primary tenant. So, day to day requests of the building may need to get channeled through the primary tenant to the building owner. More concerning is even if the owner consents to the sublease (which is yet another layer of complexity) and the primary tenant defaults on its lease, typically the owner does not have an obligation to honor the sublease and the subtenant is at risk of being evicted along with the primary tenant.
For the reasons above and a host of other factors, sublease space is often priced well below the rents being charged by landlords offering direct leases. If you are a primary tenant with excess space or a prospective subtenant, you would be wise to engage a real estate broker to help assess these factors and navigate the risks they present. If history holds true, as the underlying leases of this “sublease surge” expire, much of this space will be returned back to the landlords, continuing to create a softening in the market and provide opportunities for tenants. Whether it is taking advantage of a sublease scenario today or having more space options in the future, TaTonka Real Estate Advisors can expertly guide tenants to the right workplace solution!