Is a Sublease the Right Choice for Your Firm?

My clients often ask me if they should consider subleasing space from another firm as a strategy to minimize occupancy costs. While subleasing space from another firm may seem like a good alternative, there are several issues that must be considered before committing to this type of relationship.

Before pointing out some of the disadvantages of subleases, I believe its only fair to point out the obvious advantages: First, subleases usually are discounted by 25% to 50% as compared to “direct” space offered by the building owner. Also, subleases also often contain “FF&E” (furniture, fixtures & equipment) which can result in substantial cost savings. Additionally, some subleases may also appeal to firms who are unwilling or unable to commit to a long-term lease.

While there are certainly some compelling benefits to subleasing space, there are some significant disadvantages as well: Limited lease term; Limited tenant improvement funds; No leverage with Landlord; No control over negotiation of key lease terms.

While all of these issues are important when considering a sublease, I would like to devote the remainder of this post to what I believe is the single most important factor a for firm to consider when looking at a sublease: The credit worthiness of the firm they are subleasing from (the “sublessor”). Because a sublease is a subordinate agreement to a master lease, subtenants have little or no protection in the event of a sublessor default. So, if the firm you are leasing from is in default of its lease, and the landlord takes action and terminates that lease, your sublease is automatically terminated as well. This can put your firm in a very precarious situation.

A firm that finds itself in this scenario has two choices: Try to negotiate with the Landlord to remain in the space (at the prevailing market rental rate) or scramble to find replacement space before the eviction occurs. One strategy to eliminate this risk is to have had a recognition agreement in place at the time you signed the sublease agreement. A recognition agreement is an agreement between the landlord (building owner) and the master tenant (firm you are subleasing from) wherein the landlord agrees to recognize a subtenant in the event of a default of the master lessee. While this may sound like a straightforward solution, recognition agreements are very difficult to obtain. The best scenario would be to sublease from a tenant who had the foresight to negotiate a recognition agreement as part of its original lease. Unfortunately, these situations are few and far between.

Another strategy would be to insist that the building owner add your firm’s name to the master lease in the “notices” section. While not as effective as a recognition agreement, at least you will be notified in the event of a default and have more time to plan your next move.

If you have questions about your office lease or the office market please contact Bill White at White Space Advisors at 949-721-8880 or via email at bill@whitespaceadvisors.com.

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