5 Things Every Office Tenant Should Consider in the New Year

©2012 Darvin Atkeson / LiquidMoon.com
©2012 Darvin Atkeson / LiquidMoon.com

Over the years I’ve observed that for many tenants, once the lease has been executed it’s filed away and forgotten until it’s time to renew or relocate.  This is partially because they’re focused on their core business but also because they assume that once the lease is signed, the terms cannot be modified again until after the expiration date; this is simply not true.  Depending on factors such as a change in the building’s occupancy level, the general overall health of the local market, and even a change in the building’s ownership, improving the terms and rental rate could be achievable by the tenant as leverage may have shifted.  At the very least, a quick refresher will remind a tenant of key dates, their rights and options, or even a potential liability they’re currently exposed to.

As we head into the New Year it’s a good time to dust off your lease and ask your commercial real estate advisor to conduct a review and provide you with an updated lease abstract. Here are five things they should consider:

1.  Could your rental rate be immediately lowered?
If the rental rate you’re currently paying is substantially higher than where current market rates are, then a “Blend and Extend” strategy may be possible.  Simply put, you amend your lease to extend the length of your term, and blend the new lower rate into the present high rate, thereby immediately lowering your rent.  If your lease expiration date is too far in the future or you do not wish to extend the lease beyond that date, there could be other options as well.  Perhaps the landlord has a large security deposit on file, and you’ve made timely rental payments whose sum now eclipses the cost of the landlord’s up front occupancy costs (tenant improvements, broker commissions, etc.).  Albeit risk-adverse, savvy landlords understand that their tenants’ success is tied to their own.  Therefore, they may allow you to apply a portion of your existing security deposit towards rent, and in some cases just simply give some back.

2.  Are you aware of important notification and lease dates?
If you have the right to extend your term, the landlord typically will build notification dates into the lease.  For example, you may need to notify the landlord of your intent to renew no sooner than nine but no later than six months prior to your lease expiration.  This also goes for Early Termination, should you have that right.  Make sure to be well aware of when your lease expires, as well.  It can sneak up on you and if you don’t plan and time your renewal or relocation wisely, your leverage could potentially be substantially reduced.  Mark your calendar and stay ahead of these dates.

3.  Have you received and reviewed your Operating Expense Rent Statement?
If the landlord is passing through operating expense increases to you as additional rent, they should be providing you with an annual expense statement.  Don’t hesitate to ask your real estate advisor to review your statement for you.  If something is irregular they’ll catch it and perhaps recommend you exercise your right to audit, which tenants are usually allowed to do no more than once a year.  It’s also worth the effort to make sure expenses are not being passed through to you that were not agreed to in the lease.

4.  Does the size of your office still accommodate your needs?
Do not think that you have to “ride out your lease” if you’ve outgrown your space or perhaps have had to reduce the size of your staff.  Your real estate advisor can help you work with the landlord to relocate within the building into a more appropriately sized suite, and if one is not available, then subleasing may be an appropriate solution.

5.  What sublease rights do you have?
For many reasons, tenants often need to get out of their space in advance of their lease expiration date, and subleasing can be a wise exit strategy.  However, not all sublease clauses are created equal.  First, do you even have the right to sublease, and if so, what restrictions will be placed on you?  Are you allowed to sublease to existing tenants in the building, or tenants who have recently toured the building on a direct basis?  Can you market the space at any rate you set, or does it have to be equal to or higher than direct space in the building?  How are sublease profits shared and how much time does the landlord have to respond to a consent request?  Know your rights, and how the subleasing terms will likely affect the ability to achieve your desired results.

When several years have passed since you’ve signed your lease, it’s easy to forget what you signed up for in the first place.  Your real estate advisor can effectively and efficiently digest your lease, extrapolate key points, and then present them to you in a lease abstract within the context of today’s current market conditions.  This quick refresher is time well spent, and having a better handle on your lease’s key points and terms could prove invaluable for whatever may come your way in the New Year.

The Basics of an Office Sublease

Office subleasing can be an effective exit strategy for tenants who need to dispose of their office prior to the expiration of their master lease.  They also create opportunities for companies looking to pay a below-market rental rate within an office that many times will come already furnished and wired.  They of course come with their own nuances and can sometimes be tricky, so understanding the general mechanics of how a sublease works can save you valuable time and money.

Review the Master Lease.
Before a tenant decides they would like to put their space on the market as a sublease, they must first review their Master Lease and determine what rights and restrictions they have in regards to subleasing.  Many times the Landlord will prohibit the Sublandlord from advertising a rental rate below what is currently being offered for direct space in the building, or will prohibit subleasing to existing tenants or even yet, tenants who have toured the building within a certain recent time period.  The issue of sublease profits is also adddressed in the Master Lease and how they are handled.  Typically, but not always, the Sublandlord must share sublease profits with the landlord 50/50 after deducting reasonable expenses, such as marketing costs and brokerage commissions.

The Sublease Agreement is always subordinate to the Master Lease.
What this means is that the deal that’s cut between the Sublandlord and the Subtenant is going to be subject to the terms and conditions outlined in the agreement between the Master Landlord and Sublandlord.  Nothing within the Master Lease is malleable, and the Subtenant must conduct a careful review of the Master Lease as that’s the exact deal they’ll be inheriting. The only areas a Subtenant will have room to negotiate is in the (a) rental rate, (b) length of term (c) tenant improvements and (d) furniture use/purchase.  Also, rights that have been granted to the Sublandlord that extend beyond the Lease Expiration Date do not automatically transfer to the Subtenant.  A common example would be the Sublandlord’s Option to Extend; the Subtenant will need to negotiate a new, direct lease with the Master Landlord should they wish to remain in the suite beyond that date.

The Master Landlord must grant their consent.  
Even if a deal is consummated between the Sublandlord and Subtenant, the transaction will not be fully binding until the Master Landlord has reviewed the prospective Subtenant’s financial documents and proposed use.  Furthermore, sometimes the Master Lease will include language allowing for the Master Landlord’s “Recapture” of the office in the event of a proposed Sublease.  This clause is often exercised when the Sublandlord is paying substantially below market, as it creates an opportunity for the landlord to “take the space back”, and profit from re-letting the space at a much higher rental rate.

Sublease Term vs. New Direct Lease.
The Subtenant may have the option to simply take the Sublease for the entire term, a shorter portion thereof, or other times can negotiate with the Landlord to sign a new, direct deal thereby dissolving the agreement between the Master Landlord and Sublandlord.  If there is considerable work to be done on the space, then extending the term with the Landlord will open up the possibility of having the Tenant Improvements financed by the landlord.  Also, if the Subtenant wishes to stay in the space for longer than what the Sublease can offer, signing a direct deal can be an effective solution and can even help lower the rental rate during the additional term, as the lower sublease rental rate can be blended into the higher, direct lease rate.

Pay attention to what happens at the end of the term.
This is by far the biggest “problem area”, and where many Subtenants get into trouble by overlooking or neglecting some pretty important issues.

  1. Restoration:  If the Master Landlord requires the Sublandlord to restore the suite to its original condition prior to surrendering the space, then this must be addressed within the Sublease Agreement or the Subtenant could be left with a hefty bill at the end of the term.
  2. Furniture:  The cost of disassembling and moving furniture can be expensive, therefore clearly outline within the Sublease Agreement who is responsible for taking care of it at the end of the term.  Make a careful distinction between the right to use furniture during the term or a transfer of ownership.
  3. Staying after the term:  Since Options to Extend do not transfer to a Subtenant, dialogue with the Master Landlord should happen as soon as they’re willing to talk to you if decide you’d like to stay.  Typically, the Landlord will be receptive to allowing the Subtenant to stay since that’s their most economically beneficial option, however depending on the direction the market is trending the new rental rate could be substantially above the subrental rate.

This is of course an extremely general overview of the basic mechanics of an office sublease.  The benefits to the Sublandlord and Subtenant can be many, but there are also plenty of opportunities to get into trouble if you don’t have a strong, experienced tenant broker negotiating on your behalf and navigating you around the pitfalls.