2016 saw in influx in sublease space at a level not seen for several years. This space dump offered companies with many good options for shorter term, below market office space. However, subleases pose some unique challenges and risks over direct leases that many companies never take into account before they head down the subleasing path. Whether subleasing excess space, or subleasing space from another company, effectively managing these issues is critical to protecting your company’s interests. We recently sat down with real estate attorney Krista Kim to discuss the issues Subtenants and Sub-Landlord’s should consider before entering into a sublease. In part 1 of this 2 part discussion, we asked Krista to discuss some of the things companies should be aware of when subleasing space from other companies.
T3 Advisors: Hi Krista! The amount of subleasing over the past 12 months has been staggering and a lot of our clients are pursuing these options for the first time. What advice can you offer someone that is considering subleasing space from another company?
Krista: I think one of the biggest things to remember when subleasing space is that you don’t have a contractual agreement with the landlord. Your agreement is only with the Sublandlord you are subleasing from. This fact creates several issues a lot of companies don’t think about until it’s too late.
T3 Advisors: Why does that matter? What issues does that create for a company?
Krista: Well to start with, if the Sublandlord is subleasing their space to you because they are struggling financially, you need to realize that should they default on their lease, you will likely lose your rights to the space. That is because if a Sublandlord goes bankrupt or otherwise defaults, the sublease will automatically terminate unless the landlord agrees otherwise. If the sublease terminates, you will also lose the value of any alterations you performed. This is one of the reasons subleasing rents are typically lower than direct lease rents.
T3 Advisors: I feel like a lot of companies don’t fully understand how the Master Lease affects them until its too late. Can you touch on why this is so critical for companies to understand?
Krista: Understanding the Master Lease and how it interacts with your Sublease is absolutely critical. As a Subtenant, you inherit the Master Lease and all of its provisions except to the extent specifically negotiated in the Sublease and the Consent. Thus, you need to carefully review the Master Lease and understand how the provisions apply to your sublease.
T3 Advisors: Can you give an example of why that’s so important?
Krista: Well restoration is a big one. The Master Lease could require that the Sublandlord restore the premises to a certain condition which could equate to hundreds of thousands of dollars of work. When I represent a Subtenant, I make sure that the Sublease makes it clear that the Subtenant does not assume any obligations for restoration of pre-existing alterations. Another important one is making sure that the master lease allows subsequent sub-subleasing in the event a Subtenant needs to sub-sublease the premises (whether its to grow into a larger space or as an exit strategy). Some master leases contain problematic subleasing restrictions that allow an initial sublease by the tenant but seek to prohibit subsequent sub-subleasing by the subtenant. This is especially important in long term subleases.
T3 Advisors: Another major concern for our clients right now is zoning. We get a lot of calls from companies after they’ve moved into space, only to realize that there are major zoning challenges for their intended use. How do you see Subleases complicating this issue?
Krista: That’s a really interesting one. There is a common misconception that if you’re subleasing space from a company with your same use, you don’t need to worry about zoning. Unfortunately, its not true. You should always confirm the property you intend to sublease is zoned for your intended use. This is important even if the Sublandlord used the space for the same use and even if the Master Lease states that your use is allowed. That is because sometimes, landlords and tenants will unwittingly enter into a lease that does not conform to local zoning code. By confirming zoning, you can avoid costly mistakes down the road.
In Part 2 of this conversation, we’ll discuss what to consider when you’re subleasing space to another company.