Getting new clients in real estate brokerage is a very difficult part of the profession. Because most companies only need a broker once every five or 10 years, most brokers spend a good portion of their day pounding the phones trying to find out when leases are expiring. With everyone canvassing the market for this critical information, it’s not surprising that companies get inundated with cold calls from brokers on almost a daily basis once they get within a year or two from their lease expiration date (and even earlier for larger leases). Savvy brokers know that this is about the time their competition starts to pursue these lease opportunities. So what do they do to get a leg up? They start earlier by coming up with premature real estate strategies that, while often not viable or in the client’s best interest, at least gets the broker in the client’s door before the competition shows up. The newest scheme is the pre-emptive sublet.
During the Great Recession when the market was very soft, brokers tried to get their foot in the door ahead of their competition by promising tenants that if they renewed their leases well in advance of their lease expiration date, they could take advantage of the weak market conditions and secure immediate savings. While it was true that savings were often available, they were typically only a fraction of what the tenant could have realized had it waited a year or two and competed its requirement in the open market. The broker was able to swoop in well before his competition but the tenant lost out. Today the market is stronger so clever brokers are using a different approach to get ahead of their competition.
Since it’s hard to generate immediate savings in a strong market, a new ploy was needed to get into the client ahead of the competition. Today brokers are promising they can sublet the tenants current space thereby enabling them to move to a better space well in advance of their lease expiration. By promising the tenant that the broker will be able to sublet its existing space, the broker can get a foot in the door with the client well before other brokers are focused on this client. This sublet ploy has been an effective marketing ploy even though sublets rarely make economic sense. This doesn’t matter, however, because by the time the client realizes it’s not a deal worth doing, the broker has now accomplished its objective of firmly embedding himself into the client’s team—mission accomplished.
Here’s why subleases rarely work. Let’s assume that a tenant has 10,000sf of space and three years remaining on its lease term. Since the tenant has very little term left on its lease, it has a depleting asset that is worth less every day it goes unleased. Most 10,000sf tenants that are out in the market looking for space are already leasing other space someplace else and are looking to potentially move six to 12 months out in the future. Thus, it’s a good bet that even if the broker finds a subtenant who is interested in the space, they probably don’t want to move in for a while. Further, even assuming the broker finds a tenant, what is the likelihood that they need exactly 10,000sf? If they only need 7,500sf, they probably aren’t going to want to pay for 33% more space than they actually need—they’ll pay for only what they need. In addition, most tenants in the market are being wooed by landlords with offers of valuable concessions like free rent and tenant improvement allowances to help defray the cost of needed alterations. In order to sublet the space and remain competitive, it is likely that the sublandlord is going to have to offer some concessions as well. The sublandlord will also need to pay brokerage fees to its broker as well as to the subtenant’s broker. As a result of all of the foregoing, the sublandlord often ends up with very little net benefit from the sublet.
Of course there are circumstances under which a sublet can create tremendous value for sublandlords. There may be an existing tenant in the building who is out of space and needs to expand immediately and is therefore willing to pay a premium to get contiguous space or even any space within the building right away. Start up tenants looking to eliminate or minimize out of pocket build out costs may also find a sublet appealing and be willing to pay a premium. Longer term sublets with good credit sublandlords can provide an opportunity for long term stability and are, therefore, viable alternatives to more expensive direct lease deals. The fact that subleases often fail to provide real mitigation doesn’t mean it’s a lost cause all the time.
The fact of the matter is there are certainly times when a sublet makes sense. If there are strategic reasons to exit space today or if a tenant has already vacated its space and now wants to recover what it can, a sublet can certainly make sense as a real estate strategy. However, if a broker is telling a tenant that it can sublet their space and, therefore, the tenant should consider pulling the trigger on an early move, that should be a warning sign. Is there reason to believe the sublet will cover all of the tenant’s lease exposure or is the broker simply trying to get his foot in the door well before his competition? Fortunately, there are some ways to get to the heart of the matter and vet the intentions of the broker.
First, have the broker prepare a financial model that includes all of his assumptions and takes into account all transaction costs. When will the space be sublet, how much space will be sublet and what are the costs of the sublet including required concessions? Is the broker anticipating a discount to market rates for the sublet and, if not, why? Next, do you have the right to terminate the sublet listing agreement at any time? Is the broker asking you to start the new space search before he finds a subtenant? If so, you may find yourself obligated to a broker before you had a chance to even speak to other firms. Some warning signs that you should be on the lookout for include:
- Statements from the broker that subletting will be no problem and that the sublet will cover most of your remaining obligations.
- Pressure from the broker to start your new space search before a subtenant for your current space is procured or, even worse, pressure from the broker to sign a new lease before a subtenant is found.
- Cold calls from brokers that lead with the idea of subletting your space and moving you early even before the broker knows what your specific real estate needs are. These are often nothing more than attempts to get their foot in the door with your company before your pending lease deal is even on the radar of other brokerage firms.
Sometimes subletting excess space is a very good strategy for mitigating your current lease obligations. However, except in rare circumstances, subletting should not be relied upon to cover the tenants existing lease obligations. Brokers are always looking for ways to get their foot in the door of companies before their competition enters the picture. If a broker’s sales pitch early hinges on a potential sublet of your existing space, it should be viewed as a big warning sign that you should stop and proceed with caution.
For more information contact Glenn Blumenfeld https://tactix.com/team.php#Glenn