Sublease

An almost mythical word. Below market rates in beautiful Class A buildings with oodles of incentives offered to a prospective tenant. Talk about enticing.

But what does sublease really mean? Is a sublease a good thing, or not? Who benefits? What does it tell you about the broader market? These are all valid questions. Read on to find out!

What is it?

With a regular lease, there are generally two parties. The tenant and the landlord, or the lessor and the lessee. With a sublease there are generally two and a half parties. The tenant, sub-tenant, and landlord, or the sublessor, sublessee, and landlord (respectively).

It's important to keep in mind that a sub-tenant is bound to all the provisions of the master lease (between the tenant and landlord), and that a sublease must be approved by the landlord in most situations (refer to your master lease for clarification). It's also important to remember that a strict sublease, meaning you didn't assign the lease or weren't released from the master lease, means the original tenant/sublessor is still responsible if the sub-tenant defaults. You are not off the hook with the landlord! Naturally, you should discuss with a lawyer in order to get all the facts straight on the implications of a sublease in your particular situation.

Bad or Good?

Hopefully I didn't confuse you with the first part. Now to what you really want to know, is a sublease good or bad? Well, the easy way out is to say that it depends. Generally, however, it is a good thing. As a tenant looking for space, you should definitely consider sublease space. You will likely get a lease rate lower than market, in addition to other concessions that include free/reduced rent, some tenant improvements, and a fabulous space.

As a tenant that needs to get out of a space before their lease up (regardless of the reason), subleasing is a great option. You get the lease off your hands and are free to move to a much more appropriate space/location. In a really great market, you can actually profit from a sublease. When rates are skyrocketing, you have locked in at lower rates and can offer a sublease rate above what you are paying, and still be well below market. For example, if Class A rental rates have increased 7% annually over the past 5 years, and you are 2 years into your 3 year lease, the rate you are paying represents a 14.5% discount to market (assuming you locked your rate in at the then-market rate). So you can offer a 10% discount to the current market rate and still make a 5% profit for you! You can use that to defray commissions, tenant incentives, or a new jet ski for the summer at the lake or beach. That being said, it isn't always possible to get a greater rate than what you are paying. Most people just want to get the space off their hands. Even if you have to sublease it below the rate you're paying, it saves you a considerable sum of money over the term of the lease compared to leaving it vacant.

One thing I ALWAYS stress to sublessors is that you need to be flexible. Consider the following example:
You are leasing 5,000 SF of Class A office space for $22.50/SF. The market rate is $25.00/SF for similar space. Your monthly rent expense is $9375, not including utilities and other expenses. It seems like you could ask for $23.00 - $24.00/SF and actually make money. However, if you ask those rates and it takes 4 months to lease the office, you are out of pocket a minimum of $37,500! If you lease the space for $20.00/SF immediately, over the remaining 2 years on our lease, you are only out $2.50 * 5000 * 2 = $25,000. While that is still a considerable sum of money, the rate is much more attractive, and hence, much more likely to get your space filled quickly. The break-even on the 4 dates would mean you could market it at $18.75 and be out the same $37,500 (assuming it is immediately leased). Don't you think somebody would jump at the opportunity to save 25% of the current asking price? I think so! Do the math, you might be surprised.

Who Benefits?

Everyone! In a sublease, you either lock in a space at great rates with great incentives, or you no longer have to worry about paying rent in a space you don't need, or that can't accommodate your needs.

The Macro Implications?

Sublease properties are a tell. When there starts to be a lot of sublease property on the market, times are getting rougher (generally). Economic conditions are forcing businesses to flee their spaces for something more economical, or their business has failed and they are no longer able to meet rent. In a better market, it can signal that businesses are growing so fast that they need to expand to larger spaces. How can you tell which case you are facing? Two things: what is the local economy like, and how long are the spaces staying on the market? If the local economy is chugging along, it is probably the latter possibility. If the economy is beginning to struggle, look at the former option. Finally, check how long the sublease spaces are staying on the market. In a good market, they will move fast. Businesses just move up the proverbial food chain as they too expand. Great deals are gobbled up in a second. When the market is souring, the opposite is often true.

What it Means for Austin NOW

Based on what I wrote above, I'd like to translate that to Austin here and now, April 2008. As I talked about in one of my first posts, construction of Class A office space is incredibly high right now. Supply is coming online like crazy, and will continue to do so for at least another year.
At the same time, supply of subleases (office in particular) is rapidly increasing. There are always subleases on the market, but over the last 6 months, I have seen the number of them increase 2, 3 or 4 times (and those are only the ones I know about). This is foreboding news for those of us working office space. In addition to the increase in sublease supply, they aren't moving all too quickly. As a result of what is perceived as a softening of rates coming down the pike in the next 2 - 4 quarters, sublease doesn't represent as a good of a deal anymore. Tenants that need out of a space don't have the money to subsidize the rent as much as in good times, and the discount to market is shrinking as subsidies decrease (thus sublease rates go up), and market rates decrease.
When sublease activity picks up, that means businesses perceive that traditional lease rates are going up, so they want to lock in a really great sublease rate. Soon after, you will see the market back on the upswing. It hasn't happened yet, and I'll be sure to let you know when I see it.


Regardless of the economic conditions, subleases still represent great opportunities. My firm (especially me) do a lot of work with subleases. If you have any questions about subleasing, please visit our website at www.bulshodge.com or contact me directly by e-mail at patrick.foley@bulshodge.com or 512.480.3131.