There are more than 2 million square feet of sublease space currently available in Class A Houston buildings. And the weather prediction for the Houston office market is there is a tsunami of more coming.
Energy service companies continue to cut employees and expenditures, and will continue to add to the surplus of space. This excess will ultimately lead to aggressive pricing, sometimes desperate negotiations and, all too often, quick, sub-optimal decisions on behalf of potential sublessors and sublessees.
Companies are trying to reduce their overhead by subleasing, often holding out for what they are now paying. Sublessees, looking for a deal aren’t taking the bait.
Here’s how all concerned get a good deal and still live to talk about it.
For most sublessees, the good outweighs the bad. Not only is sublease space typically much cheaper than space leased directly from the landlord, sublessees can often get plug-and-play solutions that offer office furniture, telephone systems, even networking and computer support (make sure you get a bill of sale).
As a general rule, in addition to lower rents with shorter terms, there is often less emphasis on the subtenant’s credit than there is on a tenant in a prime lease. Subleases are great for de novo enterprises.
But, the sublessor needs to be confident of the financial strength of the sublessee. A Dunn & Bradstreet report, a banking reference and a call to the sublessee’s landlord (if any), are always warranted. In addition to the direct cost of a sublease – including any build-out, architectural fees, legal fees, and brokerage commissions – a contingent liability remains. The tenant (sublessor) remains liable to the landlord for the remaining term of the lease.
Similarly, any potential sublessee should employ the same level of due diligence on the potential sublessor. You want to know if the company has the wherewithal to survive for the duration of your subtenancy.
One way to “buy insurance” on your sublessor’s solvency is to put up part (2/3) of what is asked for as the initial consideration on a sublease, the first and last month’s rent and a security deposit (usually one month’s rent) in a Letter of Credit. That way, if your sublessor goes insolvent, it doesn’t go down with your money.
When tenants find themselves in the market for office space, and they think they want to consider subleasing as an option, in addition to doing your due diligence, here’s how to avoid making a costly subleasing mistake. Ultimately, there are three things to insist on:
- Notice from the sublessor and landlord to the subtenant in the event of a default by either the sublessor or landlord. You don’t want to be in the position of a subtenant paying rent to a sublessor who pockets your money, fails to pay their landlord, and causes the eviction of both the sublessor (tenant) and the subtenant for default.
- Authorization to directly pay the landlord in case of a sublessor default.
- Permission to cure any default by the sublessor and/or the time to negotiate with the landlord or seek alternative space.
An experienced real estate broker, specializing in tenant representation, can help size up a prospective tenant’s unique situation. Specific needs are determined based on their individual circumstances: credit, size, build-out needs, timeliness, term, budget parameters, image consciousness, proximity to employees, clients, etc.
Of course, although sublease space is usually taken on an as-is basis, in the current environment, everything is negotiable. And, potential sublease tenants can expect sublessors to show them the money.
For potential sublessors, go ugly early, and be ready to deal. Have your lease, any amendments, estoppel certificates, nondisturbance agreements, etc., ready. Time is money, and time kills all deals.
This article originally appeared in the Houston Business Journal, May 8, 2005.