September 9

Sublease Agreement, Subletting, What is the Sublet Definition?

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Subleasing can be a confusing scenario for many business owners. If you own a business, you should know all about what it means to sublease. In addition, learn about subletting, sublease agreements, and understand the sublet definition.

We’re going to breakdown this sometimes-complicated subject and make it really simple and easy to understand. So, let’s jump in!

 

What is the sublet definition?

A sublet is an agreement between a tenant and another tenant, as opposed to a landlord. In most scenarios, a tenant leases space from a landlord. With the sublease, a tenant leases space from another tenant.

The most common reason for this to occur is when the original tenant has too much space. This business owner needs help paying the rent. In a strong market, sometimes businesses have too little space. In this example, they need to move into a larger space.

Basically, when a tenant has too much space or too little space, they need to move and find a replacement tenant. So, let’s explore how this works.

 

How long does a sublease last?

Typically, a sublease lasts until the end of the original term for the original lease. As an example, if a tenant has 2 1/2 years remaining on their lease with the landlord, that tenant would look to find a replacement tenant to agree to those remaining 2 1/2 years.

It can sometimes be a challenge to find a tenant who will agree to an often-shorter term lease. Oftentimes, the original tenant will discount their lease rate to make the sublease more attractive to a subleasing tenant.

If the subleasing tenant wants more time than the sublease allows, they can negotiate that extension directly with the landlord. At this point, the lease rate will go back up to market rates. The subleasing tenant still gets the value of the discounted lease during the period of the sublease.

Here is an example:

The original tenant is leasing 5,000 SF at $20.00/SF. There are 2 years and 6 months remaining on the lease. $20.00/SF is considered the market rate. A subleasing tenant negotiates to take over the 5,000 SF and pays $15.00/SF. The original tenant will still have to pay the $5.00/SF to make sure the landlord receives the full $20.00/SF. Paying $5.00/SF is better than paying the full $20.00/SF, so they agree to do so.

For the two and a half years remaining on the lease, the subleasing tenant is getting a $5.00/SF discount off the market rate. In this scenario, the subleasing tenant will receive the following value: $5.00 x 5,000 SF x 2.5 years = $62,500. That is some real value right there!

These deals exist in nearly all marketplaces, but you often won’t see them. We’ll cover why that is near the end of this post.

 

When should you consider a sublease agreement?

There are two perspectives on this. Let’s look at it from the original tenant’s perspective and then let’s look at it from the subleasing tenant’s perspective.

First, from the original tenant’s perspective, a sublease is usually offered for economic reasons. This original tenant is either growing out of their space or they have too much space and they’re not using it all. In both cases, money could be lost.

If a business is growing out of their space, they’re trying to operate out of a space that is not efficient for their business. This can cost them money.

If the business owner has too much space, and they can’t fully utilize it, then they are wasting money on paying too much rent. In both cases, this original tenant would be better served with a space that better matches their needs.

Second, from the subleasing tenant’s perspective, a business may be uncertain about their expected growth. This subleasing tenant may want to save money on their lease as they test the waters. If the subleasing term is close to what they want from a landlord, then they could potentially save a lot of money by subleasing from another tenant.

In addition, in most sublease scenarios, the liability for the space remains with the original tenant. For instance, many landlords require tenants to be responsible for paying insurance, real estate taxes, and common area maintenance (CAM) expenses. In addition to these expenses, original tenants are often responsible for making rent deposits and personal guarantees.

With a sublease agreement, subleasing tenants can often avoid these added expenses and liabilities. In many sublease agreements, the subleasing tenant simply makes an agreed upon monthly payment to the original tenant, and the original tenant is still responsible for all the expenses and liabilities described above.

 

Why does subletting work?

Subletting works when two motivated parties come together and sign a sublease agreement.

A sublet works well for the original tenant because it provides a way to receive some income to offset the expense of the remaining term of the lease. This is just one of several ways for a tenant to save money on their leased space. An example of another way for tenants to save money is through rent abatement, and you can learn more about that here.

 

In most cases, a landlord expects to receive full rent for the remainder of the term.

Exceptions to this may include the following:

  • The landlord needs the tenant’s space to increase the leasable space for an adjoining tenant. This may help keep a larger tenant in the owner’s building.
  • The landlord has a replacement tenant willing to pay more rent per square foot.
  • There may be a tenant willing to sign a longer-term lease than the time remaining on the original tenant’s lease.

Remember, most landlords want more money per square foot and longer-term leases.

Subletting tenants benefit from having a sublease as well.

In most cases, a subtenant can negotiate a below market lease rate. It is usually rare for a subtenant to take over a leased space at the full rate that the original tenant agreed to pay. The discount on the lease rate could be 20% or more. This could be enticing savings for a subleasing tenant.

 

Why is subleasing difficult?

Subleasing is not as common as a direct lease between a tenant and a landlord. Due to shorter lease terms, many commercial brokers avoid them because they will not earn as much commission as they would on a long-term lease of 3 to 5 years or longer.

Unless you have a tenant rep focused solely on your best interests (as they should be), they may not even show you sublease opportunities. This can be for multiple reasons, including a shorter term and difficulty in getting paid a commission.

Most landlords are prepared to pay a commission, but since they already paid a commission to the broker that brought them the original tenant, they will not likely want to pay another commission when they already have a tenant on the hook to pay rent.

When a tenant is looking to sublease their space, they may already be facing economic challenges, and they too, will not want to pay a commission to your tenant rep.

With this in mind, if you have a tenant rep working for you, you should discuss how you plan to compensate them, and this will ensure that you see all possible deals. After all, the reason you hire a commercial tenant rep is to get representation focused on you!


David Haug

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About the Author

David Haug is a Madison WI commercial real estate broker. He is passionate about helping clients, customers, and friends succeed in finding property, selling and leasing property, and investing in real estate. He is also a raging Badger fan. #OnWisconsin Baby! Connect with David on LinkedIn: https://www.linkedin.com/in/davidnhaug/

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