Breaking Up Is Hard To Do – Sometimes

Can't we just sublease?

In this environment where the deals are hot, hot, hot, it would seem difficult to “go long” with a landlord and commit to a 10 year or even longer lease. While the benefits of locking in the low cost environment will clearly be the gift that keeps on giving, how do you know what your business will look like in 12 months much less 10 years? How do you know how many employees you will have, and what happens if the whole space just doesn’t work anymore?

If business leadership is going to be able to reasonably commit to a long term lease, then they will need real estate to provide flexibility to both grow and contract over the term of the commitment. We describe three fundamental strategies to provide flexibility in this post. Please be aware that few things in life are simple, and almost nothing in a lease is simply stated. Make sure you have good representation – both real estate and legal – before you attempt these strategies for your company.

Sublease. A sublease allows the tenant to lease all or a portion of the premises to another tenant. While this might seem like a logical approach – after all it is your space – the first issue is to understand that you are competing with your own landlord. The ownership is in the business of leasing space for a profit, and you are trying to offset a cost. In most all cycles of the market you will need to sublease your space for less than your current rate, and likely less than the landlord is leasing space for in the rest of the building(s).

One of the real keys to a tenant advantaged sublease provision is attempting to get the right to sublease to others currently in the building. Again, the landlord views this as a competitive situation and will be very reluctant to provide this option. Also, be very clear about when you can continue negotiations with companies from outside the building. Some landlords will restrict you from subleasing to another company if the landlord makes a “proposal” to them. Does proposal mean oral, written and what happens if you were proposing first? All things to work out before you need to sublease.

While there are many other issues in the sublease arena that tenants need to be aware of, the other big league item of note is notification. When you make a deal with a subtenant, the landlord must approve the transaction. You want to hear from the landlord within a very few days (as opposed to say 30) because everyone wants to get on with it. Except the landlord who likely wants your deal to happen. Tell the landlord that you are willing to give them a reasonable period of time, but you are paying for this lease, and the ability to sublease is an important part of the deal. Time kills all deals, so negotiate a quick answer up front.

Expansion. Getting too big for your britches? Well, at least in the corporate sense this is a good thing. When you leased the space way back in 2010 it seemed just right, but now you won that big contract and now you need to hire a squadron of people. Why don’t you just ring up the landlord and ask for more space? Because markets change and you lose leverage when you have committed to a building.

So, pre-negotiate the ability to grow under favorable terms and conditions. There are a number of devices to accomplish this goal including a so called “must-take” which compels the tenant to expand on a certain date under agreed upon deal terms, a “right of first option” which give the typical tenant the option to take space when it first becomes available and a “right of first refusal” which allows the landlord to continue and market space but gives the tenant the right to jump in front of any other interested party.

Termination. If they space no longer works at all, or if it is surplus then a tenant can negotiate a right to terminate the lease with a payment. Most terminations options today will call for a certain date on which the lease can be ended and a formal notice provision. For example, a landlord might agree to a one time right to terminate on the 7th anniversary of a 10 year lease. Keys to negotiating this clause include: negotiating a relatively small payment compared to the rest of the remaining obligation and making sure that notice is as close as possible to the date of termination. The closer the notice, the more flexibility the tenant will have.

To sum it up, at least in the world of real estate, business can “have their cake and eat it too” by properly negotiating flexibility in leases. So now you can feel better about going long on a lease contract with favorable economics.

Ken Ashley

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