You need to be familiar with subleasing as this will be your primary method of ending your occupancy if you find that you no longer require the property.
Inexperienced business owners often say something like, “I’ve talked with my landlord, and he/she is okay with letting me out of my lease.” The vast majority of those people come to find out there are stipulations to the landlord, letting them out of the lease, and those stipulations aren’t as flexible as they expected.
It can be possible that the landlord allows you to terminate the lease, but usually only when they have another tenant lined up or need to use it themselves. What I find in practice is that many landlords won’t want you to terminate the lease, but if you frame it right, or approach it at the right time, it is possible to get the lease terminated. I handle 3-4 lease terminations each year. They follow one of a few common themes.
The best-case scenario is the sublease that turns into a lease termination. By taking this route, you are earning your lease termination by finding a new tenant for the landlord. If you can find a tenant that will pay as much as you or more and who wants the space for as long as you have left and preferably longer, why wouldn’t the landlord allow you out of your lease to get a better deal?
My distribution client in Memphis, TN had a west coast distribution is in Cerritos, CA. We had been working together for ten years and had a handful of leases under our belt when the CEO called me. He said that a conglomerate had purchased his largest customer and that the acquirer intended to take distribution in-house. That meant that in three months, my client would have zero need for the Cerritos warehouse and would be stuck paying $12,000 a month for the next 48 months.
We put the building on the market for sublease for starters. Being in the market every day, we knew that there was excessive demand for space, and people were coming to us from all over LA County trying to satisfy this demand. You see, Cerritos could not be more centrally located. Downtown LA is 20 miles north, the two largest ports in the US are 20 miles west, Orange County is 20 miles south, and the Inland Empire distribution hub is just 20 miles east. We were able to leverage that activity into getting our neighbor to step up and provide an offer to lease the space for seven years at a higher rent than our current contract. We took this proposal and their financials to the landlord. Now we had the landlord’s attention. Upon lease signing, we signed a termination with the landlord, effectively canceling our lease. My client was happy to be able to mitigate the budget impact of the customer’s loss by getting out of this satellite Cerritos warehouse lease. We were able to negotiate with the neighbor to buy the forklift and furniture to relieve our client from the trouble of shipping them back to the corporate headquarters.
The alternative to terminating the lease would have been a traditional sublease. In a conventional sublease, we would spend the next 48 months hoping that the subtenant pays the rent. We would know that we would be responsible for rent if the subtenant went under. We would also have to work with the subtenant on future repairs, deal with issues between the two parties as they arise, collect and hold onto a security deposit. At the same time, the landlord would continue to hold on to our security deposit. At the end of the lease we would deal with the surrender of the property, walkthroughs, etc. All of this time spent dealing with the subtenant, the executive could be using to rebuild the company. Be wary of landlord language stipulating that you split any excess rental amount from sublessees with the landlord.
When you are negotiating the lease document, you can’t count on the future prospect of terminating your lease, you need to also protect yourself in the event that you actually need to sublease the space. Remember, just because you have subleased your space, you are still responsible for it until you, or your new subtenant, has fully discharged all of the obligations of the lease.
Key terms to negotiate in the sublease section is the amount of time and cost of the landlord’s approval of your new subtenant. Some leases will give the landlord too long of a time to review the sublease request, where others will require their consent. Usually you can arrive at a fair amount of time and the release of your requirement to wait for their approval if they go over their allotted time. You will find that the landlord will want the ability to charge you for their own time, effort and attorney to review any sublease request. Many leases don’t cap these expenses. It is helpful to arrive at a fair flat fee amount or an amount “not to exceed.” These expenses are per occurrence, so it you try to sublease your space once and it doesn’t work out, you will pay this fee again with each attempt. This is fair as it does take time and effort at a minimum to review each request.
Lease Option to Extend
You do not have to be in the business long to hear someone say that they want a two-year lease and three one-year options to extend the lease. People love asking for options. They feel like it is giving the landlord something by showing their intent to remain in the property even if they are signing a short-term lease upfront.
It is commonly understood within the brokerage industry that options are of benefit to the tenant but that they in no way benefit the landlord. An option obligates the landlord to keep you as a tenant if you would like to stay. An option does not enable the landlord to keep you as a tenant if you wish to leave.
The way I look at it is that an option can be thought of as a last resort or worst-case scenario. If we need to stay in the property and the landlord really doesn’t want us to stay, we have the option to continue to be there. Other than that, I generally avoid them and focus on negotiating the best deal upfront.
One of the main reasons I avoid asking for options is that the actual lease option language that is used within lease contracts becomes is, by default, already so watered down that you aren’t really getting anything other than a more restrictive set of rules that will dictate future lease negotiations.
Common lease option language states that:
- In no event shall the new rental amount be lower than the prior rental amount
- No tenant improvements shall be included
- No free rent or leasing concessions shall be included
- If you cannot agree to a rental amount you and your landlord must hire two appraisers who then hires a third independent appraiser when then decides your fate through baseball arbitration
99% of the time that we have an option, we choose not to use it and we start a new negotiation. It is through dealing with the current management and property owner that we can then go about assessing our needs, understanding the landlord’s motivations and striking a new deal that is good for everyone. I’m open to changing my mind on this opinion, but 500 negotiations and a national client’s insight, has helped me understand a better way to approach this then relying on option language.
That said, if you have an option to extend and you are going to negotiate a new lease, it is helpful to think through when you are going to do that. For example, you can negotiate a new lease before your Option to Extend window opens so that you still have it in case you think it will be valuable. Some landlords may ask you to waive your option to extend in order to pursue new lease negotiations. That is ok, you just want to be intentional about it.