Key advantages and disadvantages for tenants to consider when looking to downsize and sublet office space.
In a climate of increased flexible working, the size of our offices going forward has been a consideration of many organisations all over the world.
Remote working, or a ‘work from anywhere’ approach, has allowed us to reconsider what constitutes an ‘office’, and what is needed in this space.
This has prompted many businesses in recent months to explore the option of downsizing and subletting part of their current office space.
Subletting is when the existing tenant (lessee) rents part or whole of their leased office space to another business or organisation.
In this case, the lessee becomes the sub-lessor, and essentially acts as the landlord to the incoming tenant (sub-lessee).
The head lease agreement between you and your landlord stays in place but you will also have a separate agreement between you and your sub-lessee, known as the sublease.
The key advantageous reason why many tenants consider reducing floorspace and subletting is to save costs.
If a tenant has taken a space that is now too big for their current needs, then every excess square meter is costing money.
In the current economic climate of the COVID-19 pandemic, this is all the more relevant in that not only are there economic challenges, but months of working from home has allowed some organisations to appreciate that business functionality can still be maintained with a smaller office footprint.
If you no longer need as much office space, then clearly, you are paying rent (at pre-COVID rates) for space you don’t need.
By carving off this space and subletting unneeded space, this can allow the tenant to recover some of the costs for otherwise ‘dead’ space and bring in some extra cash flow.
If you are starting to consider whether you should downsize and sublet office space, the first consideration is that you should look at is your existing lease with the landlord, and see whether you are actually allowed to sublease part or whole of your space.
In some instances, landlords stipulate in the lease that the tenant may not take on any additional subtenants, so this is important to look out for (also something to consider when signing a new lease).
If the lease does allow you to sublet office space, then the next step is to see what conditions apply to this, and what restrictions may be in place.
Whilst you may have space available to sublet, it is very important to gauge what demand there is for the type of space you have to offer, and whether you will actually be able to find a suitable subtenant.
A good place to start is usually with nearby tenants in the building, or even on the same floor.
Assuming that your lease allows you to sublease to tenants within the building (careful, because some leases stipulate against this) you may find a nearby tenant is wanting to expand – a perfect fit to whom you can sublet office space.
Screening potential subtenants is also critical – if not the most important consideration.
While subleasing can be a great way to generate some extra cash-flow, you do not want to take on the wrong type of neighbour (i.e. a competing industry or a business that has a high risk of defaulting on payments).
A further consideration is the nature of the space itself that you are looking to sublet.
Some factors that may promote or hinder it or the size of the space (too big or too small), the remainder of lease length (tenants may be unwilling to take it on if its too short), the quality of the building, and ease of access to the sub-tenancy.
All these factors may also be compounded by current stock levels of sublease options, particularly as a result of Covid-19.
For example, the Melbourne CBD market saw an increase of more than 50,000m2 of sublease space between December 2019 and June 2020; a record increase that has pushed sublease stock far above the long-term average.
If there is more supply in the market than tenant demand, then it can become increasingly hard to sublet space, and even if you can, possibly not at the rate to make it a viable option.
Depending on the nature of the space you are looking to sublet, there may be some cost disadvantages associated with being able to sublet office space.
Firstly, an important point to remember: while you will be receiving income from rent received, it is usually regarded in the market that subleasing will only ever recover 50% or less of the rent you are currently paying.
If you are looking to sublease whole floors, this can carry very minimal if any costs as no structural changes will have to be made; perhaps just some removal of signage.
If you are looking to sublease part of a floor however, you will have to consider the costs of separate entrances and potentially dividing walls.
Additions such as a kitchen or amenities may also be necessary depending on the nature of the space.
As a sub-lessor, you will have certain responsibilities that must be maintained.
Remember, your existing lease originally signed with the landlord is still in place, and unless a new agreement has been made, this must be upheld.
In fact, in many cases, landlord approval must be sought for any sublease arrangements, so be sure to have this in place before any agreements are signed.
Agreed obligations such as maintenance standards and a make-good will still apply if in the original lease, and you must still pay the full rent amount, even if your new subtenant defaults.
Remember, the sub-lessor is now effectively the landlord for the subtenant, so maintenance queries and tenancy issues will also typically come through the sub-lessor as well.
There are certainly a number of factors to consider before deciding on making the move to sublet office space.
While sometimes advantageous for businesses, it certainly is not always the best solution and should be considered in the context of your longer-term property strategy.
If you are considering these options, it is strongly recommended to undertake a strategy session of what your workspace requirements are – both now and longer term – in view of achieving the best possible solution to your business needs.
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