Why Is Subleasing So Commonplace?

The Logistics of Leasing

We’re in the tightest market in the country, with one of the lowest vacancy rates for industrial real estate of any market, and yet there are 83 subleases available in the LA Basin for warehouses larger than 20,000 SF.

Subleasing is an integral part of the warehouse leasing business for companies that are just getting started or that have a general company policy of leasing. Your business growth spurts may coincide with your lease expiration, but this is the exception rather than the rule. At some point, there will be a mismatch, and this is when subleasing comes into play.

So why is subleasing so commonplace? The first occurrence is the life cycle of a business. If you started your own business, you might remember a time when you were bootstrapping your business, trying to win every contract, and worrying about making payroll. You were trying to save every penny possible. Many companies that start this way, and work through organic growth, will look for sublease property because it is an opportunity to get a below-market lease rate. It is also an opportunity to sign a short-term lease, as you are leasing the remaining time of the master lease.

For larger companies, experiencing sustained growth, or the execution of a new business contract, can warrant a larger facility to increase capacity before the end of the existing lease. If that is the case, it may make sense to sublease your existing building so that you can move to the new larger facility before the expiration of your lease.

When this is the case, one of the first questions most people ask themselves is, should we put our space on the market for sublease first or should we sign the lease on the new building first? On the one hand, you don’t need to get rid of your old building until you have your new building. On the other hand, subleasing space doesn’t happen overnight; it could take weeks or even months. The reason it can take a while is that you have to find the right tenant, review their financials, draft and negotiate a sublease document, gain landlord approval, collect all monies due, receive and review the certificate of insurance, and have a fully executed sublease and master lease. In today’s supply-constrained market, subleases have a faster velocity than in prior years.

As I write this, we are in the middle of the COVID-19 pandemic. This crisis has increased the quantity and velocity of the sublease market for the following reasons:

  1. Apparel companies with products that have arrived from China cannot go to shuttered retail stores
  2. Companies that have lost customer demand are downsizing
  3. Companies that have excess space are looking to lower overhead
  4. Food delivery companies are expanding as is the need for additional cold storage
  5. Personal Protective Equipment, PPE, is being manufactured and distributed in great quantities for an unknown period of time

It turns out that subleases have more moving pieces than the original lease because there are three parties involved: the sublessor (the party that no longer needs the space), the sublessee (the party who needs the space), and the master lessor (the landlord who owns the building).

The initial negotiations are between the sublessor and the sublessee. The sublease contract memorializes this negotiation. The sublease contract, however, does not supersede the agreement between the sublessor and the master lessor. That means that two documents need to be reviewed, taken into account, and approved by all three parties.

What if two parties agree to something that the third party doesn’t? What if the two parties are ready to move forward, but the third party doesn’t feel comfortable and needs one of the two parties to change their agreement? What if the current tenant doesn’t have any issues with the city, but the new tenant’s use brings up code violations?

Every sublease negotiation involves new variables and nuance that must be worked through until all parties are in agreement. If they cannot come to an agreement, or it is best only to have the new tenant and the landlord in the negotiation, it might make sense to terminate the original lease at the same time that the landlord is signing a new contract with the new tenant.

Contact Grant, Anne or me to go over your lease and figure out what is the best sublease situation for you.

Justin Smith, 949.400.4786, jbsmith@leeirvine.com

Grant LaBounty, 562.310.2048, glabounty@leeirvine.com

Anne Ginthner, 949.790.3151, aginthner@leeirvine.com