Situations change rapidly in California’s business climate. What happens when a business needs to pivot, quickly?
Recently, I wrote of the ways in which you can extract yourself or your company from a lease obligation.
As a quick recap: Leases are contracts that allow occupancy for a certain period of time (term) and for consideration (rent). As an inducement for your tenancy, an owner (landlord) may offer some goodies – free or abated rent, an allowance to fix up the place or the right to extend your lease or buy the premises (options). In return, you agree to pay on time, stay the full period of the lease and take care of the building. Easy, right? Not so fast.
Sometimes circumstances arise whereby the agreement must be tweaked. In the extreme, a dramatic decrease in revenue leads to bankruptcy. Conversely, an uptick in sales could cause the need for more space. If a competitor is acquired or if the operation is sold, another shift occurs. Now, you have redundancy — too many facilities serving the same purpose. What to do with your leases?
Remedies abound. You can sublease the building, buy out, allow the term to expire, reject the lease through bankruptcy or default. Clearly, the last two are not recommended as there are legal consequences, but they are a way clear.
Most opt for one or a combination of the first three, sublease, buyout or term out. But what are the differences and when should they be used? Please allow me to dive a bit deeper.
Simply put, in a sublease you locate a surrogate — a group to replace you.
But, don’t forget, there may not be another “you” readily available. Did your operation lease the first building you toured? Probably not. You considered multiple locations until you found the perfect fit of lease rate, landlord motivation, amenities, concessions and term. Now, you are the landlord and must meet the nuances of tenants in the market. All, while having little flexibility.
Your goal is to get out with as little downtime and expense as possible. Remember, your rent and term are known. Where is that rate compared with comparable availabilities – above, below or right at market? If you’re below, count yourself fortunate! You’ve something to offer.
So, how do you deal with an enterprise seeking a three-year lease when you’ve committed to 10. Plus, you’ve consumed the inducements. By that, I mean your free rent burned off or the new carpet is old now. To compete, you may have to consider offering some giveaways.
Subleases are messy! I’ve found the most success when the rent is below market, a lengthy term remains (such as 5 years, plus), and the building is in pristine condition.
An owner of commercial real estate spends significant dollars to originate your occupancy. First, he sat vacant while his agent marketed the availability and searched for a tenant, all while continuing to pay the bank and operating expenses.
Secondly, that free or abated rent is another cost. Third, painting the offices and adding new flooring isn’t cheap.
Finally, he paid professionals to negotiate the lease. All told, an owner will outlay 15-25% of the lease term’s rent in origination costs! He then recoups the expense over the term.
Therefore, if you approach your landlord with the question: “What’s it going to take to let me walk?” He will surely account for all of the above.
Generally, tenants find the price too steep and opt for another avenue. But, I’ve encountered situations where buyouts make sense. Typically, a spread exists between the stated rent and the current market. A mid-term of 2-3 years remains. And little cleanup is necessary.
Term. Clearly, is the easiest, but it’s seldom used. Why you might ask? Because the ends rarely meet.
Sure, if you could time your company’s demise with the expiration of your tenancy, boom! Problem solved. Unfortunately, the dangling participle of the term generally must be severed.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at email@example.com or 714.564.7104.
Source: Orange County Register