With so much disruption in the office marketplace, some office real estate users may find their best fit to be sublease space that offers pre-built conference rooms, lunchrooms and offices along with furniture and additional amenities. It’s rare to have so many sublease options available but it makes sense for tenants to consider them given the substantial financial discount offered when completing a sublease.
Our research of the office sublease market combined with our anecdotal experiences with both tenants and landlords shows that the Minneapolis/St. Paul market has the largest amount of sublease space ever available, even more than during the Great Recession in 2008 through 2010.
In early July, there were 62 Class-A options having more than 20,000 square feet with than 24 months plus remaining on the lease and another 54 office options in Class-B and Class-C properties.
However, a vast amount of the square footage being offered as sublease space is more than 50,000 square feet. Of the 62 Class-A options, 43 are larger than 50,000 square feet. Users for those size spaces are not traditionally subleasors, but already one large sublease option of 300,000 square feet has been taken by Thomson Reuters in the Eagan-Prime Therapeutics headquarters.
When it works:
Subleasing works well for start-up or growing companies that might not have the capital to pay for the expenses of construction, furniture and AV equipment. Those growing companies also want flexibility for future space needs or to test a temporary second location.
For those companies, sublease space works best when there are three to five years of rent left on the lease contract. In many cases, sublease space can be leased for up to a 50% discount on the direct rent for the same space.
Our team is working with a company right now that is considering two subleases with longer lease terms. This business needs around 30,000 square feet. Although there are numerous options to sublease office space throughout the metro, only two options fit their specific criteria.
With one option, the 30,000-square-foot space has 10 years left, which pencils out to an obligation of $9 million. The original tenant may consider writing a check to the landlord for half of the obligation. The landlord can then use that money to fund a new longer-term tenant and offer, in the words of many, “a pretty sweet deal” to the new tenant.
The new tenant benefits because it can occupy the space as-is with little or no improvements, avoiding a large capital expenditure for furniture and improvements.
If your business is considering a sublease space:
- Review the credit of the original tenant. If you are paying the original tenant, that tenant also needs to pay the landlord. If that original tenant stops paying, your company could get kicked out of your “sweet” space or be asked to pay significantly increased rent.
- Understand how subordination works. If you have a verbal agreement with the new landlord, the written language will supersede a verbal agreement if the building is sold.
- Understand the terms and conditions of the original lease. Some language – such as the number of parking spaces, the hours of allowed operation, allowed use – may not work for your business.
- Evaluate whether exclusives are included in the lease language. Those exclusives may preclude specific businesses – mortgage or title company for office space or a competing specialty medical practice – from occupying a vacant space.
- Finally, review the credit of the landlord. Many owners of office space might have financial challenges due to the rising interest rates and declining occupancy rates in office properties.
When it doesn’t:
A company’s size may not be as big as a deterrent as once thought given the number of large sublease spaces available. But the specific configuration of the space may not work even if the size is a fit.
Subleasing also may not work because the subtenant must agree to take the space in its current state – and with its lease obligations. Subtenants with unique space uses or more parking needs than the current contract allows may be better off finding vacant space and negotiating for those unique needs directly with the landlord.
Like any lease obligation, subleasing is a contract that needs to be fully understood before being executed. In all cases, businesses should have the appropriate counsel to represent them — not the original tenant nor the landlord – to ensure that their needs are met for the short-and-long term. Of course, I’d suggest you contact one of Forte’s advisers for our experience, personal attention and in-depth knowledge of the costs that get rolled into any lease term.
Katie Trevena is vice president – Advisory for Bloomington, Minnesota-based Forte Real Estate Partners. She has been involved in commercial real estate for 16 years and serves and supports office and healthcare clients.