The Three Parties in a Sublease

With San Francisco commercial property rental rates up 20% or more during the past three years, subleasing a space can be quite profitable for both the tenant and the landlord. In most subleases, profits after marketing expenses are split equally between the landlord and tenant. In a number of leases, however, landlords have a right to recapture, thereby gaining an opportunity for greater profit.

A landlord typically has 30 days to accept or reject a sublease. The landlord may also have the right to terminate a sublease and take over the premises. In this case, the tenant is released from any future obligations to the space; additionally, the tenant would lose any profit. The risk the landlord takes in such a situation is if he or she cannot recover the costs associated with marketing the space, time, legal fees, and possibly new tenant improvements.

What happens to the subtenant if the landlord waits for the full allowable time to respond and then recaptures? The subtenant may end up without space and find himself or herself back at square one in the search for space.

What if the landlord does not have a recapture clause but does not want the tenant to profit from the space? The landlord can create problems for the tenant and subtenant:

• The landlord can wait the maximum amount of time to approve the sublease, potentially forcing the subtenant to pull out.
• The landlord can disallow any new tenant improvements to the space that the landlord feels does not conform to standards but that the subtenant requires in order to make the deal.
• The landlord can disallow any extension of the sublease.

A landlord has an incentive to accept a sublease if he or she believes there is an opportunity for that new tenant to stay in the space longer, thereby avoiding potentially costly vacancy expenses.

Few subleases are available these days. If a tenant needs to get out of a space, most landlords are willing to negotiate an early termination clause to release the property for higher value. Remember, the landlord needs to show the highest rental value in order to maximize the value of his or her asset.

All sides in a sublease negotiation should start negotiations early to know exactly how the landlord plans to deal with a potential sublease. If the landlord does not respond promptly, the deal might be in trouble. It’s better to know sooner rather than later to avoid costly downtime while looking for replacement office space.