The tease of a below-market short term sublet (steal!)

One of the more popular requests I have been getting is for short term,  class a sublet space. The clear advantage here is receiving a tremendous value of paying sometimes less than half of what you should be paying for a space and getting the opportunity to rent it short term. Everyone feels smart cashing in on someone “desperate” situation trying to unload space they don’t need and it’s logically the way to get the most aggressive deal.

Of course, there are certain situations where this works out beautifully, but there are a lot of common problems that arise. To illustrate, here’s an experience I recently had.

I was referred a customer that was running a start up company well-funded by a billion dollar company and with principals with years of experience in the industry. They wanted a space with a couple offices and bullpen for about 40 for 1-2 years with a budget in the mid 30s.  The second most exciting prospect was a gorgeous Madison Avenue building that had a 2 year,  furnished, 5000 sf sublet willing to do a high 20′s deal (the most exciting prospect got taken off the market about a week after it was put on).

The existing tenant was paying north of $80 psf so that would be almost 1/3 the rent! This is great for the term of the lease, but if the subtenant holds over, they would be responsible for about $240 psf (about $100,000 per month), since the overtenant has a holdover clause requiring them to pay 3x the rent in the event of a holdover. In the high 20s psf, the sublease is only worth about $300,000. So if the subtenant holds over three months (or two months and one day), the overtenant is in the red. Plus they had to pay legal, brokerage and other expenses. It would take about 10 months security (at $11k per month) to even cover one day of holdover and good luck convincing a start-up to give that much deposit on a short term lease.

As is the case in a lot of these situations, the overtenant is a successful company that has outgrown the space. This means that even though they are losing money on the space and willing rent it for much less than it’s worth, they are not “desperate”. If they were really desperate and having problems, a) the company would probably default on the lease and the landlord would recapture it or b) you wouldn’t want to rent it from them since you would risk losing your sublease if they do go under.

Obviously, an overtenant is not willing to just hope that undertenant moves out in time risking $100k per month. If it’s not a company with a very strong track record, they won’t take the risk and well established companies are not usually looking for short term space. If one of the principals of the company would sign a personal guarantee or good guy guarantee, then they would take on that responsibility. But who wants to be personally on the hook for $100k if move-out isn’t timely? And not only that, the person signing would need to demonstrate pretty substantial funds in order for the overtenant to even be comfortable with them taking responsibility. Also, what if they pass away or leave the country?

If you are a well-established company looking for short term space (maybe for a project?), then a below market sublease is a great solution. If you are a start-up it can also be a tease. It might make more sense to take a sublet closer to market to avoid the draconian holdover penalty and at least give yourself the option for extending the lease after the term so you don’t need to move again right after the lease is up. Having the option to stay in your space after your lease is always a nice thing to have, but if your rent is going to double or triple, it’s not considered.

To capitalize on a really below market sublease, you must be a very strong company with an established track record in order to be approved.  Also, you will not be able to extend the lease at a similar rent (so effectively no option to renew or even stay an extra couple months). Finding a sublet more in-line with market is less tempting, but can often be a more practical solution.

Eli