Subleasing is complex because there are three parties in the transaction and two sets of negotiations happening simultaneously. In the following, we show how to sublease space, whether you’re a landlord, tenant, or sub-tenant. Furthermore, we set out the advantages and disadvantages for each party when subleasing commercial property such as office, retail or industrial.
WHAT IS A SUBLEASE?
A sub-lease occurs when a tenant rents part or all of a premises they are leasing to a secondary tenant. Effectively becoming the sublandlord. A sub-lease is a separate agreement from the original lease with the landlord.
The original lease is the “head lease” and remains in effect, and all parties involved sign the new sub-lease contract:
- landlord
- tenant, sub-landlord
- sub-tenant
GAINING APPROVAL TO SUBLEASE
The process is normally set out in the tenancy agreement to protect the landlord from losing control over who occupies their building and its use. Before even considering subleasing space, a tenant should refer to their lease agreement to check the tenant’s right to sublease the property. Generally speaking, there will be a term detailing the tenant’s right to sub-lease, but sometimes it may require written consent from the landlord. A formal letter, in accordance with the notice provision in the lease, is the best way to take action.
If the tenancy is quiet on the ability to sublease, then opening up a discussion with the landlord is the best place to start. Most landlords don’t withhold their permission unreasonably as long as the sublease covers their interests, and any upside in rental rates is split accordingly between the parties.
WHAT TO CONSIDER WHEN DECIDING TO SUBLEASE OR NOT
There are some important things to consider when contemplating subleasing:
1. The tenant needs to check whether their lease allows subletting or licensing. Normally, you require consent from the landlord and some other pre-conditions.
2. If a landlord agrees to a sublease or licence, the tenant normally needs a deed of consent to the sublease or licence.
3. Tenants will normally need to cover the landlord’s costs for the process. Such as giving consent and reviewing agreements.
4. When choosing a sub-tenant, you need to ensure they will suit your business. Checking credit references, previous year’s accounts, and proof of cash on hand to comply with the financial obligations of the sub-lease is prudent. Furthermore, ensure there is no conflict or reputational issues with your business if subleasing part of your space.
5. If a sub-tenant fails to pay rent, the original tenant is still liable to the landlord for the full lease costs and any late fees or recovery costs. There should be a make-good obligation and a security deposit so that if the sub-tenant breaches the sub-lease, the sub-landlord has protection to call on to remedy the issue.
6. A commercial sub-lease agreement is a binding contract that sits under an existing lease contract with the landlord. You will need to involve a lawyer to address your interests throughout the two agreements. The existing tenant is now the sub-landlord, while the new tenant becomes the sub-tenant.
WHY WOULD A TENANT SUBLEASE?
One of the main assumptions is that the tenant is attempting to sub-lease because they are struggling financially. To ensure the tenants don’t fall into arrears on rent, they sublease to supplement their rent obligations. If they default, it makes for an unhappy landlord who tends to be less cooperative with other aspects of the lease.
However, not all tenants looking to sublease are in trouble financially. Some have outgrown their space, or their business model has changed, which makes the space obsolete. Others may have decided to buy their own space.
However, what starts as a sub-lease can often end up as a lease termination agreement between the landlord and the original tenant and a new direct lease with the would-be sub-tenant. This is the main goal of going into many sub-lease negotiations, especially for the original tenant, because they can wash their hands of the space completely. Another option, if allowed in the lease or agreeable by the landlord, is to assign or transfer the lease to the would-be subtenant.
THE PROS & CONS OF SUBLEASING COMMERCIAL PROPERTY
There are many advantages and disadvantages to subleasing commercial property. Although there are three fundamental drivers that make the option appealing for the parties involved. The landlord’s interest is to ensure the rent payments continue for the duration of the lease. The tenant’s main driver will be minimising the financial burdens of underutilised space. Whereas the subtenant will look at the savings they can achieve by not fitting out the space.
Advantages for the tenant (sub-landlord)
Allows for downsizing: If a business has downsized, subleasing part of the premises surplus to requirements ensures continued rent affordability for the business. The tenant will save rent payments on space that is surplus to their requirements until the lease ends. Moreover, reducing the need to negotiate a break of the lease with the landlord and relocating to smaller premises.
Allows for growth and relocation: Sub-leasing old space allows businesses to move on to larger premises without needing to break their own lease and saves on the costs that would be payable for leaving early.
Other Benefits: When sharing a space with one or more sub-tenants, there may be a benefit of sharing resources, customers, networking, a reduced carbon footprint, and workplace diversity.
Disadvantages for the tenant (sub-landlord)
Finding a sub-tenant: It may be hard to find a high-quality tenant, as short-term lease arrangements don’t suit everyone.
Additional workload for managing a sub-tenant: Allocating resources to manage the subtenant can waste time and energy for the sublandlord. Especially in addition to their own administration under the existing lease. As the sublandlord is still liable, this needs to be resourced adequately.
Lease obligations remain unchanged: You will still be 100% responsible to the landlord for the obligations under the head lease. If the sub-tenant fails to pay or damages the premises, the sub-landlord needs to cover the lease obligations.
Advantages for the sub-tenant
It’s simpler and more flexible: A sub-lease is generally easier to qualify for and can be more flexible by allowing month-to-month occupation or shorter agreements, such as 6–12 months. It can be perfect for new businesses or temporary projects.
The property is functional and fully furnished: Sub-leased spaces are fitted out, furnished, and ready to occupy. A sub-tenant usually won’t need to budget for fit-out costs; even things such as alarm systems or internet access will be wired in.
Option to take entire space: If the sub-landlord wants to move out entirely, they can sub-lease the entire space.
Disadvantages for the Sub-tenant
Business Compatibility & Image: You may be limited in how you can use the property. Furthermore, it is key to make sure the other businesses in the adjacent spaces are compatible with yours. Things such as branding, industry, and noise issues.
Unfavourable lease terms: To protect your rights as a subtenant, make sure a solicitor reviews the sub-lease agreement and the original lease before signing. The original lease may put limits on your ability to use the space as you wish as a subtenant. Moreover, make sure you’re aware of the market comparables at the time of the sublease. As the sublandlord may try to pass on a bad deal they negotiated previously. Such as elevated rental terms to cover the above-market rent they are currently paying.
Risk of default by the sublandlord: The main risk to consider is the chance of the sublandlord defaulting on or breaking the terms of the head lease. If this happens, a subtenant will lose access to the premises. To cover yourself as the subtenant, you can include a sub-lease clause in the lease. This will enable the subtenant to recover costs and damages for being evicted as a result of the sublandlord defaulting.
Delays in maintenance services: If the sub-tenant needs repairs to the property by the landlord under the head lease, there is a chain of command that will take time to go through. This creates delays with the problems being addressed.
Less flexibility to customise: The sub-tenant has little control over the layout of the space to suit the business brand and needs. You are dependent on the decorating tastes of your sublandlord. Furthermore, you will likely be limited to the changes you can make under a sublease.
Advantages and disadvantages for the landlord
There are fewer considerations for a landlord. The main positive is that they have another party that will aid with the payment of the rent. If the tenant is struggling financially, having another party to help pay the rent and stop the tenant from defaulting. By having more guarantee the tenant will uphold their obligations to the landlord can only be positive. The main aspect to be aware of as a landlord is the loss of control over who is in the building and the use class. As the landlord has less control over the selection of the subtenant, it can affect other tenants and the reputation of the area or facility.
LIABILITY UNDER A SUBLEASE
When a tenant sub-lets a lease or licence, they will still be liable under the tenancy agreement as head lessee and will not have obligations such as paying for rent, repairs, or reinstatement at the end of the term. If there is a maintenance issue that relates to any of the landlord’s obligations under the head lease. It would be the sub-landlord’s job to approach the landlord and carry out the communication for the work required.
