What to do When You Are Stuck with an Unleaseable Building

Published on Monday, 20 January 2014 11:34:56    Written by Marc
If you have been doing lease management long enough, you have probably come to this situation more than once: You are asked to sublease a building or space, which your company no longer needs, and try to sublease it for months until you come to think that you have a dead horse on your hands. However, is it really the case or are you simply positioning your site on the market the wrong way?

Unleasable siteLet us look at a few examples and your options in each of these situations.

You have an office space which your company no longer needs (I take an office space here, but the following applies to just about any type of site, including commercial, warehouse, industrial).

So in our case here, what are the factors that influence your chances of ever subleasing that space? Let us list them below:

1. Location
2. Size
3. Quality
4. Term remaining
5. Price
6. Additional features

These six items are the main elements that will drive your chances of subleasing your site. I will leave out some elements like zoning because they are a given. If a potential subtenant needs a heavy industrial site for his/her operations, it is obvious that he will target only sites, which either already have this zoning or in some rare cases, can easily get the required zoning. Although, considering the time it takes to rezone a site, this would be a very rare exception and I doubt any subtenant would risk taking a site that does not already have proper zoning.

If we look at the main elements in detail:

  1. Location. Obviously, where your site is located is a major factor. However, what does location really mean when you are subleasing a site? What do potential subtenants taking into consideration when they are thinking about location? The answer can be one or a combination of the location elements here:

    1. Specific district/area. If the subtenant needs to be in a particular area, such as a financial district for example, either for its normal business or in order to attract specific type of employee the area will be of major importance. In addition, if the employees are dominantly living in a particular area, the subtenant might prefer to find a site as close as possible to where the employees already live.
    2. Access to public transportation (metro, bus, proximity to airport, other)
    3. Access to sufficient parking for employees
  2. There are obviously other location elements than subtenants can consider, but the three above are probably the most popular. Among other elements you can include crime rate (more and more subtenants verify the crime rate of a neighborhood before leasing or subleasing a site).

  3. Size. This one may seem like a no brainer, if the subtenant is searching for a particular size of space, he/she will not be interested in your site if it is too small. However, if your site is too large for the subtenant needs, you might be able to do one of two things:

    1. Give the extra space away for free or at a deep discount. This could mean for example having the subtenant only pay for the operating expenses and not for base rent. Again, we need to remember that we are dealing with a site that is difficult to sublease and sometimes it is better to manage to sublease 80 percent at a good rate and give away the remaining 20 percent, or have the subtenant pay only for expenses on that remaining 20 percent than to lose the deal completely.
    2. Divide the site into two or more spaces. This however, is not a decision to be taken lightly as depending on the layout and your existing lease it may be impossible or cost prohibitive. I made a post on this subject a few weeks ago about Beware of the Real Cost of Sub-dividing a Site.
  4. Quality. The quality of the site is always a factor, although one could argue that when the economy becomes more difficult, people become more flexible on the quality criteria since they go for better (lower) rental rates in order to save money. Maybe even more so the companies which seek to sublease a site. After all, if you are subleasing a site it may be because you do not want to commit to a long term, which are more standard in head leases.

    Alternatively, it may be that you operations are growing and you do not want to settle down in one space for now. It may also be simply to save money, as subleases tend to be less expensive that head leases, especially if the term is short. Therefore, although quality of the site is important, people searching for subleases generally tend to be flexible on this element and unless your site is really a poor quality one, this alone should not make your site difficult to sublease. In many cases, it may even help the process, as a number of companies, such as start-ups or industrial companies, will welcome lower quality sites if the rate is competitive.
  5. Term remaining. This item is a major one (often the most important of all). If the term that you offer is shorter than the term that your potential subtenant is seeking, that means that your subtenant will need to make two leasing deals, one with you and one with the landlord of the building if he/she want to lease the space. However, aligning the interest of everyone is often (read always) a challenge. For example, suppose a potential subtenant of yours wants to lease a space for 7 years. Now, 7 years is an odd number because many leases go for either 5 or 10 years, but as we know each company is different, you the term can really being anything.

    Suppose also in our example that your lease ends in 4 years, so you can offer your site to your potential subtenant for those 4 years. If your subtenant needs the space for 7 years, that means that he/she will have to go see the landlord and make a deal to lease the space for the remaining 3 years (years 5,6 and 7). The problem with this picture is that most landlords will prefer to wait because they have no immediate benefit in doing a lease that will procure them revenues only in 4 years from now. Most landlords would prefer to wait and see how the market will behave and try to find a tenant that will lease the space for a full 10-year term.

    In this situation, your potential subtenant will have difficulties convincing the landlord and may have to take a chance on leasing your site for the first 4 years and crossing his/her fingers that he/she will be able to make a deal with the landlord in 4 years to extend the lease. Because of this, most subtenants try and find sublease terms that meet as closely as possible their needs in the first place. If your lease is too short, you might have difficulties in convincing your potential subtenant of taking your site and taking a risk on the landlord.

    However, if your term is a bit longer than the needs of your subtenant, you might want to lease your space for the period that the subtenant wants it and provide an extension option at a fixed rate. For example, if you have 4 years left on your lease and find a potential subtenant that only needs the space for 3 years, you might accept to do that 3-year deal to generate revenues and offer your subtenant with a lease extension option at a given rate.

    In 3 years from now if your subtenant needs an extra year, it will be available. You could also offer your subtenant to take the 4th year at a discount. Of course, you should always push to make your sublease co-term with your own lease in the first place. However, as indicated above, we are dealing with a site that is difficult to sublease.
  6. Price. The price is always an important factor in any lease, so it is not different in a sublease. Actually most companies seeking a sublease do it to get reduce rent rate, so price is important. However, when comparing your asked price to other sites (something always good to do as if you price your site out of the market it will obviously not help your subleasing process, don’t be surprised if your site does not lease if you are not competitive), you should take into consideration your total offer versus the market. For example, suppose your site goes for $25 a square foot with everything included (a real gross lease) and your lease expires in 5 years so you offer a term of 5 years.

    Now suppose the landlord has a space in the same building on the market and he is offering a 5 year head lease at a rate of $30 a square foot but gives a $20 tenant inducement and provides an option to renew for an extra 5 years. You will need to calculate how much the tenant inducement, which is given at the signature of the lease, is worth over the term of the lease (considering the value of money in time). But even if you do a few calculations and find out that your offer is about the same as the landlord’s one, you need to keep in mind that the fact that the landlord can offer a 5 year renewal and you can’t could make a big difference. When you consider how much it costs companies to move, if the potential subtenant leases your space, he/she needs to consider the potential cost of moving in 5 years versus taking the space of the landlord and potentially renewing the space for an extra 5 years, thus eliminating the cost of one office move.

    So, compare yourself to the market but do not forget other considerations. Items such as number of parking spaces offered can make a difference in the eyes of a potential subtenant so do not forget all elements in your offer.
  7. Additional features. These elements need to be evaluated on a case-by-case basis but can sometimes make or break a sublease deal. For example, your site might have a feature that your potential subtenant absolutely needs or wants for his/her operations. It might be something that you already installed, something that came with the building, equipment in place, a building feature (for example high or size of electrical entrance). Look to see what additional feature you can offer that other sites might not have.

    These additional features are probably more found in commercial and industrial spaces but some offices might have some additional features worth marketing, such as server rooms, phone systems, or furniture. However, some features that might be great for some might be bad for others. If your site has a feature that you think is great, it might not even be needed for a potential subtenant.

    For example, I remember we once had a manufacturing site, which had a new HVAC system for heating and cooling, and the only subtenant we managed to find wanted the space for a warehouse. Not only did they not need the HVAC system in place, we had to pay to remove some of it to allow the subtenant to stack pallets high enough. What we were selling as a great additional feature was actually a nuisance for the subtenant. Had we been able to find a subtenant that had a need for HVAC we could have probably received a higher rent, but this was a difficult site to lease and we were in 2009, in the midst of the economic crisis, so we were happy to accept what we could get at the time.

Summary

In the end, remember that the vast majority of buildings or spaces are leasable. It may not feel that way if your site has been on the market for one or two years with little prospects to show for, but before throwing in the towel, look at what features you offer and how your offer ranks compared to the market. Then try to position yourself in the shoes of a potential subtenant to see why your site would be interesting or not to lease. If you are working with a broker, ask him/her specifically what type of subtenant he or she is looking for.

While most brokers do a good job in identifying potential types of subtenants, it is not always the case. I once worked with a broker, which was trying to sublease an older office site which had come to us in a company acquisition and for which we had no need anymore. We out it on the market and did not have any serious prospects for over a year until I sat down with the broker to ask him what type of client he was targeting for our site. He told me he was pitching our site to all his prospects.

After our talk I asked him to concentrate on companies that are either downsizing, commercial companies that needed extra space or industrial companies, ideally companies which would not receive clients at their site or if they did, that the clients would not care if the site was a class C type. Less than six months later we managed to lease the site. I found out later that he had been initially pitching our site to companies including accounting and law firms. That was a mistake since these firms typically receive their clients at their site and no one wants to go see a lawyer that has his or her office in a rundown class C building. However, our site was perfect for other types of subtenants. Sometimes it is only a matter of targeting the right type of subtenant.