Given how popular subleasing has become over the past couple of years, we sought out the expertise of Laurie Sanderson, Partner at Gowling WLG, to go over some tips and traps for both prospective sublandlords and subtenants. Put simply, a sublease is used when a tenant wishes to rent some or all of their leased space on terms that do not directly mirror the terms of the tenant’s lease.
Most often this happens when the tenant wants to lease only part of their premises or if the rent to be paid by the subtenant is more or less than the rent paid by the tenant under its lease. A sublease is a separate agreement between the tenant, as sublandlord, and the subtenant. The tenant’s original lease remains in effect and is often referred to as the head lease.
If you’re a tenant and decide to sublet your property, you must understand your obligations under your existing lease as well as the new obligations that a sublease will create. Similarly, if you’re becoming a subtenant, it is imperative to be aware of your responsibilities both under the head lease and the sublease and to negotiate accordingly so as not to take on additional risks or responsibilities that you shouldn’t have to.
Getting ready to sublease
If you’re a tenant looking to sublease all or part of your leased space, you first need to make sure that your lease allows you to do so and investigate any specific conditions that will apply. With many leases, you have to seek your landlord’s consent.
“You need to be aware of any permitted use restrictions, landlord prohibitions on to whom you are permitted to sublease your premises, and whether the lease mandates any required terms of the sublease, as for example, that the sublease rent cannot be less than the head lease rent, as well as how long the landlord has to reply to your request for consent. I suggest that you have your real estate broker or agent engage with the landlord proactively to address any impediments to securing a qualified subtenant.” — Laurie Sanderson (Partner, Gowling WLG)
It’s worth having your agent negotiate with the landlord in advance of putting your space on the market to avoid any future complications and unintended pitfalls. There could be restrictions like not allowing the space to be subleased to existing tenants in the building, that it can’t be subleased at a lesser rent, or even negative impacts on your existing tenant rights (e.g. forfeiture of parking spaces, signage, options to extend or terminate).
The trap you’re trying to avoid here is finding out after the fact that you have inadvertently forfeited important rights or, after both the tenant and subtenant have spent significant time and money pursuing a sublease, finding out that the proposed sublease or subtenant is not permitted under the head lease. Your agent can negotiate with the landlord to waive or scale back some of the restrictions before going to market.
Laurie recommends that you prepare a redacted copy of the lease to give to your subtenant together with a non-disclosure agreement. There are often confidentiality requirements in the lease that limit the tenant’s ability to disclose the terms of the lease to third parties. To avoid trouble later on, you’ll want the redacted lease to exclude terms that the landlord would object to you disclosing.
You will also want to exclude terms that you do not intend to flow through to the subtenant (e.g. rights to transfer without consent, ability to audit operating costs, options to renew, etc.). If you’ll be including furniture and equipment in the sublease, you will also want to do an inventory of everything beforehand so that there is no misunderstanding as to what is included and excluded, but also to avoid having to do this in the midst of trying to close your deal.
Selecting your dance partner
Whether you are a subtenant or sublandlord, it’s important to choose your sublease partner carefully. As a sublandlord, you need to make sure the subtenant has the financial ability to pay the rent as well as adhere to the financial and other obligations of the sublease. Remember, if the subtenant is unable to pay the sublease rent, the sublandlord is still liable to pay the rent owing under the head lease.
Subtenants also need to vet the sublandlord. If the sublandlord defaults on their rent, the landlord may terminate the head lease which would then terminate the sublease as well and leave the subtenant in a very precarious situation. Depending on the structure of the head lease and sublease, the subtenant may even be responsible to pay the outstanding head lease rent.
In addition, where the sublease is for only part of the sublandlord’s premises (ie where the sublandlord and subtenant are essentially sharing space), each party will want to be sure that the manner they’ll be carrying on business is compatible with each other.
“If you’re going to be sharing space, each party needs to be sure that their uses are compatible. For example, a conservative law office sharing space with a free-wheeling software company may not work as they each carry on business quite differently.“ — Laurie Sanderson (Partner, Gowling WLG)
Beyond having a harmonious working relationship, factors like security requirements are also important to consider. Medical, law, and accounting offices have high confidentiality requirements. As a result, access throughout the shared space needs to be dealt with in a way that respects these requirements.
There’s also a conversation that should be had regarding allocating shared costs such as realty taxes and operating costs. Often, the split is done on the basis of the rentable area but the conversation should be framed around the usable area so that shared reception areas and conference rooms are properly accounted for. Otherwise, the sublandlord will end up paying more than its fair proportionate share of these shared costs.
What we’ve outlined here is a quick overview designed to help you understand the basics of subleasing but it is no replacement for representation. If you’re considering subleasing your office space or are looking into space that’s available for subleasing, make sure to seek out legal expertise and have your commercial agent negotiate thoroughly on your behalf. In our next post, we’ll explore the offer to sublease, the sublease itself, and finalizing landlord consent.
Real Strategy believes that incredible people deserve amazing space! Contact us today so we can analyze your situation and provide you with the answers you need to see if subleasing is an option you should consider.