A significant number of companies are looking to sublease their office space to right-size their portfolios following the coronavirus pandemic. Here’s what you need to know about subleasing your office space, including when it makes sense, how you could benefit, and what challenges are common, plus five helpful tips and best practices to consider.
The office sublease market has grown significantly as companies re-evaluate their real estate portfolios.
As of Q2 2021, office sublease space has risen by 80% since March 2020 in the U.S. While some markets have experienced a slowdown in new offerings and some sublease space has been withdrawn, the market remains at historic highs. There are myriad reasons for this spike in availability, ranging from staff reductions to lowered growth expectations to a rise in remote and hybrid work policies.
U.S. OFFICE SUBLEASE SPACE INCREASED BY 80% SINCE MARCH 2020
*Sublease availability rate
Source: CoStar Group and CBRE Tech Insights Center, June 2021
But whether a company is just starting to explore how to sublease excess office space or already in discussions to do so, there are a number of questions to answer.
In this article, we’ll explore factors to think through before subleasing your office space:
When and Why You Should Consider Subleasing Your Office Space
Over the past year, a growing number of office tenants have explored the feasibility of subleasing their office space and have questioned when and why they might consider it.
The answers will vary, but there are two common reasons a company might consider subletting its office space:
- A company doesn’t need as much office space: Whether a company has changed its business projections to address slower-than-expected growth or is planning to extend its remote work policies after COVID-19, some office tenants are finding they just don’t need all the space they are currently leasing.
This also extends to companies that are exploring hybrid work, a workplace strategy that offers employees the choice to work remote or from the office. Where a company might once have invested in enough office space to house all its employees, a business exploring hybrid work may need less office space as it plans around a more remote-friendly workforce.
Some companies experiencing strong growth may also lease more office space than they currently need but plan to grow into it. They will often sublease their unused office space for a period of time until they are prepared to use it.
No matter the circumstance, the core rationale is always the same: A company finds itself with excess space it doesn’t need, and subleasing this excess space helps offset costs.
- A company has outgrown its office space: Despite the economic uncertainties wrought by the pandemic, some companies have experienced higher-than-expected growth and have consequently outgrown their office space.
Many of these businesses plan to continue offering their employees the flexibility to work remote after the pandemic abates. Others are fully embracing hybrid work. Even still, these companies have decided that the office plays an integral role in their business and are now on the market for a larger office space to house their workforce.
If their current landlord can’t help them expand their real estate footprint in their existing asset, companies will often explore the potential to sublease their current office space to help offset costs while they relocate to a larger office space before their lease expires.
The Benefits of Subleasing Your Office Space
While company circumstances may vary, a business likely will see two common benefits when subleasing their office space:
- Subleasing excess office space can help you recover some of your liability: While subleasing excess space does typically involve upfront costs, an organization can recover some of the liability they have on space they aren’t using over the course of a sublease term.
In practice, this means a company can expect to offset some of their leasing costs with revenue from a sublessee. This cost-avoidance strategy is a material benefit for companies that successfully sublease out excess office space.
- Subleasing can help a company right-size their real estate portfolio: For some companies, the biggest material benefit subleasing excess office space offers is the ability to rightsize their office space holdings.
In real estate portfolio planning, companies often take more space than they need as they seek to model their office space holdings on business projections for headcount and organizational growth.
But those business projections are just that: projections. A company can sometimes exceed its own projected growth plans—or fall short of them.
The challenges of subleasing your office space & what to consider
Despite the benefits companies see when subleasing out excess office space, there also are challenges. Case in point: It’s not always a simple process.
Here are the top challenges to consider:
- It can be difficult to recover your total lease costs: While it’s sometimes to recover your lease costs by subletting your office space in a rising market, it can be difficult to do so in a weak market. Added to this, lease terms often restrict a tenant’s ability to sublet space at a profit.
- There can be downtime: Depending on market demand, you should anticipate some downtime before you are able to successfully sublease your space. The length of this downtime can vary by geographic region and local occupier demand, but it’s helpful to take this into account when planning to sublet your office space.
- There can be additional upfront costs: In negotiations with a potential sublessee, you may come across additional capital outlays to remodel or reconfigure your office space.
5 Helpful Tips to Successfully Sublease Your Office Space
Once you’ve decided to sublet your office space, you must take steps to both prepare your office space for listing and reduce the time it takes to find a subtenant:
- Review your lease agreement: First, it’s critical to review your lease to make sure you have the right to offer your space for sublease. You also need to identify any consent restrictions or recapture rights—i.e., the ability for your landlord to take back your space if it’s favorable for them to do so.
Landlords typically require the ability to consent to any sublease to ensure their rights are protected. Depending on your lease terms, they may also have rights to share in any net profits your sublease generates.
It’s a best practice to reaffirm your sublease rights and limitations as well as perform a financial impact analysis prior to bringing your space to market.
Keep in mind that upfront due diligence will help your organization make a firm commitment to sublease your space in a way that benefits your interests in a competitive market.
- Set realistic expectations for cost recovery and analyze the financial implications: Most tenants should expect to sublease their space at a discount to their total costs in today’s market.
These discounts can include variables such as expected downtime, reductions in the base-rent cost for a sublessee, free-rent incentives to attract occupier interest, tenant improvement allowances for reconfiguring an office space, and subleasing commissions, which are paid to brokers.
From an accounting perspective, you may also need to prepare for the possibility of lease-impairment charges, which a sublease may trigger.
- Prepare your office space to be marketed for sublease: Once you’ve affirmed your right to sublet your space, it’s critical to prepare your office space for marketing and make sure it’s move-in ready for a potential subtenant.
Move-in ready space is especially important in the sublease market, as few companies are looking to commit large sums of capital to make additional space improvements.
Your space should be “showroom ready,” and you should be clear about what furniture, fixtures and equipment will be included with the sublease.
Once your space is ready, you’re set to begin scheduling in-person tours. You should also consider filming your office space to enable brokers to schedule virtual tours, which are recommended to enhance your marketing efforts and save time for prospective tenants.
- Vet the financial strength of all potential tenants: When you sublet your office space, you are likely to remain responsible for all obligations per your lease, including paying rent to your landlord.
As such, the financial health of any subtenant is important to evaluate to ensure they will be able to fulfill the rent obligations.
In most cases, a subtenant will also seek to vet your financial status, since they are at risk for eviction or potentially higher rent if you default on your lease.
It’s rare for a landlord to assume the terms and obligations of a sublease, making the financial health of your company and your subtenant critical to gauge before executing a sublease.
- Consider negotiating with your landlord as an alternative to subletting: Before you sublet your office space, it can be worthwhile to discuss potential contractual changes with your landlord.
In negotiations, you can explore modifications that insert more favorable clauses around subletting your office space. You can also try to remove additional sublease costs that are contained within your contract.
There are even some instances where it may be worth exploring an alternative to subleasing your space. This can include terminating your lease directly with the landlord so that they can cut a deal with a new tenant directly.
This strategy can come with benefit; Namely, you are no longer on the hook for the lease and the new tenant will likely be able to obtain additional concessions from the landlord and additional protections they wouldn’t otherwise get via a sublease.
But terminating a lease can also carry disadvantages . The biggest—and most obvious—is that you’ll need to pay an upfront termination penalty (though this fee is typically negotiable). Moreover, any termination of your lease will likely be contingent on the landlord’s being able to lease your space to a new tenant.
For more information on the latest market trends in commercial real estate, explore cbre.com/thewayforward.
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