Strategies for Surplus Real Estate

WHY IS SUBLEASING THE ONLY RECOGNIZED OPTION FOR
MITIGATING THE LOSS OF SURPLUS OFFICE SPACE?
Up until the savings and loan scandal of the eighties, real estate developers enjoyed some latitude with lenders as to the value and potential pro-forma of their office projects. Since that time regulations on lending practices have forced developer/landlords to a much tighter qualification process. Before, developer/landlords had more latitude in deciding the best alternatives for empty space, the lenders leaving much to the discretion of the landlords.
Today, lenders almost exclusively base the quality of their loans on the “income approach” to valuation. Therefore, to loose a percentage of a loan’s income can, and will de-value the loan forcing the lender to require additional equity in the project – or justify the loss to their stockholders.
Since then, landlords have required tenants who no longer need or are using space in their buildings to “sublease” the space themselves. This gives the landlord the luxury of maintaining the income and guarantees from the tenant, even if they find a subtenant. It also creates a tremendous loss for the tenant needing to sublease the space.
If your company has surplus space and time remaining on the lease, what are you to do? If you call your landlord you are likely to receive the answer – “Sublease it”. They will probably offer their own brokers services which will seem reasonable. But the landlord’s broker works for your landlord. The landlord will see to it that any potential tenants are shown their own empty space before yours.
ONCE YOU BEGIN THE SUBLEASE ODYSSEY – KEEP THIS IN MIND:
1. A SURPLUS LEASE IS NOT A REAL ESTATE ISSUE – IT’S A CASH-FLOW ISSUE.
Finding a subtenant is not the issue at hand. Timing and speed of execution are the true issues. Every month the space sits vacant costs your company thousands in lost after-tax income. The goal should be to find the fastest and least expensive method of mitigating this loss. Subleasing is neither.
2. ASUBLEASE IS PERCEIVED BY THE MARKET AS A "FIRE SALE"
According to the Business Post, “Most commercial real estate brokers will advise a potential tenant wanting to sublease their space that their space will trade in the 50 cents on the dollar range.” (Business Post, Subleasing Can Be Painful, February 2005). After leasehold improvement allowances,
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broker commissions, and numerous other costs – some known and some hidden, a sublease will rarely return more than 37 cents on the dollar – and that’s a best case scenario.
3. SUBLEASING ATTRACTS BOTTOM FEEDING TENANTS
High credit companies do not seek sublease space. Subleases attract cash and credit poor tenants who usually are unable to qualify for a new lease. Also, once their sublease ends – the new tenant is subject to a new rental rate which the landlord controls. But more importantly, what happens when your new subtenant can't pay the rent?
4. FINANCIAL REGULATIONS SPECIFICALLY TARGET SUBLEASE ACCOUNTING
According to GAAP financial rules (FASB 13 – Interpretation 27), surplus space must be written off at the time you intend to vacate the space. If you sublease the space and the subtenant defaults, you may be required to immediately write off the entire remaining lease balance including all anticipated costs including the furniture, fixtures and equipment you may have installed. Furthermore, if you are trying to sublease and your reported sublease income expectations are below your expectations, you may be required to immediately write off that additional loss.
5. ASUBLEASE REQUIRES YOU TO PUT UP "AT RISK" CAPITAL
A sublease typically requires an up front cash investment for leasehold improvements as well as your broker’s commission. These standard out-of-the-gate expenses are needed to attract what often ends up being a poor credit subtenant who is at great risk of default, essentially making it more of a gamble than an investment.
6. ASUBLEASE PUTS YOU IN THE REAL ESTATE MANAGEMENT BUSINESS
Subleasing means you are now a landlord since the sublease is between your company and your new subtenant – not the landlord. Therefore any of your subtenant’s office building requests and requirements must be handled by you first, not the landlord. All requests for repairs and maintenance, collecting rent, parking lot accident liability, etc. are your responsibility. When the toilet backs up the subtenant must call you, not the original landlord – who is no longer directly liable for such repairs. This takes a lot more time and money than most expect and is a “dirty little secret” of subleasing.
7. THE VALUE OF YOUR SUBLEASE DECREASES WITH EVERY DAY
Every month that your space sits vacant it becomes less attractive to prospects. Subtenants know that shorter term subleases mean they will soon face large rent increases once the sublease terminates. History shows that opportunities to sublease fall dramatically when the lease term remaining drop below 36 months.
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