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Commercial Subletting

What are the pros and cons?

Subletting all or part of your business premises to a third party can be a great short-term strategy to give yourself some extra cash flow and reduce the sting of paying rent.

It makes sense if you’re downsizing your business and you simply have a lot of unused space in the building, office space or on the rural land that you’re operating from.

Commercial subletting sounds like an easy extra revenue source but it’s important to understand your rights and responsibilities when agreeing on the sublease with the new tenant.

What is subletting?

As a business owner, you can either own the property you operate from or lease a property from someone else.

If you’re leasing the property, you would have a lease agreement in place with the commercial landlord which stipulates your lease term and your rights and responsibilities as a lessee, including maintenance and repair of the premises.

Subletting is when the lessee rents all or a portion of the premises to another business owner.

In this case, you as the lessee become the sub-lessor, since you’re effectively acting as the landlord to the incoming tenant (sublessee).

To make things even more confusing, the lease agreement between you and your landlord stays in place (now known as the head lease) but you will also have a separate agreement between you and your sub-lessee (the sublease).

Your tenant deals with you and pays rent directly to you rather than dealing with the landlord.

This type of arrangement is common with large office buildings in metro/CBD areas, where the building itself is owned by a body corporate or strata company and they lease out the premises to a property management company such as Jones Lang LaSalle or Knight Frank.

The property management then sublets separate units, suites or floors to businesses.

What are the benefits of subletting?

Subletting isn’t really a long-term investment strategy but rather a short-term strategy to reduce some of your fixed costs so you can get more cash flow in your business.

It’s also great for the subtenants, who may only need a small amount of space in order to operate and can enjoy much lower rental costs and not have to worry about the costs of maintenance and repairs.

There are typically three reasons why a tenant would sublet their premises:

  • Tough business situation: If your business is in a lull, it makes sense to rent out of part of your premises to a short-term tenant so you can save on rent and pump more funds into your business.
  • Downsizing and streamlining: Actively choosing to downsize happens in the world of business, particularly in the manufacturing and industrial sectors. Instead of having to move, you can continue your running your business from the premises by subletting extra space in your warehouse or factory.
  • Closing up shop: If you’re planning to move due to business expansion or you’re simply retiring, you may want to sign up a subtenant for a short lease term with the view to eventually assume your lease. By having the subtenant take over your lease, you can avoid lease termination costs.

What are the drawbacks of subletting?

Subletting isn’t for everyone. You should consider the following:

  • Finding a tenant: If you’re in a location suffering from an oversupply of retail or commercial space, you may struggle to find a tenant let alone one that’s willing to sign on for a short term lease.
  • Responsibility for the property: Ultimately you, and not the subtenant or the landlord, are responsible for maintenance and repairs on the property.
  • The risk of rental reliance: If subletting is essential to you meeting your rent, this can be highly risky since the subtenant can actually leave at any time.

Does the lease agreement allow subletting?

The first thing you need to do if you’re considering a commercial sublet is to confirm whether the terms of your own lease agreement will even allow you to do so.

Landlords are generally risk-averse and would rather have one strong tenant than someone who needs to sublet just to make rent. It also adds another layer of complexity when it comes to managing tenant disputes.

In addition, the landlord’s insurance may not even cover property damage if it was committed by the subtenant.

Whether the lease agreement allows you to or not, you’ll need written consent in order to enter into a sublease agreement with the new tenant.

With office space, most landlords will allow the sublease to go ahead, albeit, they will be taking into account whether your tenant choice compliments the tenant mix of the building.

It gets a bit more difficult with industrial and retail businesses or any businesses that require purpose-built property in order to operate.

You should consider:

  • The load bearing capabilities and clearance heights of the building: This relates to subletting factory or warehouse space to a third party. It may be appropriate for your business operations but not for the new tenant.
  • Security, OH&S and fire safety: The building or land may not be appropriate for businesses that have high legislative requirements such as a child care centre, restaurant or aged care facility.
  • Parking: Having to negotiate with potentially three parties for parking space can be a nightmare.
  • Signage requirements: The new tenant may want signage and fit-out work done that the landlord will not allow for the purposes of re-selling.

Examples of sub leasing

  • Office space: You can let floor space or a suite to someone else.
  • Warehouse or factory: This mainly involves subletting floor space but it may include subletting an extra office suite that you may not need.
  • Rural property: If you’re leasing rural or farmland for your agribusiness, you can sublet part of the land to someone wanting to set up a small farm or even build a residential property and hobby farm (if zoning allows mixed residential/agricultural use). Leasing agreements are notoriously informal when it comes to farm land so it’s best to speak with a qualified solicitor who can help with drafting up the lease agreement.

Negotiating the sublease

The sublease can actually be significantly different to the head lease you have with your landlord.

The first thing to note is that the lease term granted to the sub lessee cannot be longer than the lease granted under the head lease.

Other things to consider include:

  • Use of facilities and parking: Your own lease may grant you exclusive access to facilities like the bathroom, kitchen and parking but you may decide to place some restrictions on the subtenant.
  • Exclusive possession: If you (the head tenant) operate on the same premises, the sub-lessee has the right to exclusive possession of at least part of the premises, as stipulated in the sublease.
  • Make good the premises: In order to meet your own obligations under the head lease, you may make it a requirement that the sublessee make good the premises at the end of the sublease.

It can all get very complicated so you’ll definitely want help from a solicitor!

How do I work out rent?

In the same way that rent is charged to you as the tenant, the rent you charge the subtenant will be determined by the property’s location and the size of the space that is being rented, on a square foot basis.

A commercial buyers agent can help you determine how much rent you should be charging.

It gets a bit more complicated when it comes to agricultural land as income earning potential also gets thrown into the equation.

Most commonly, leasing rates are based on a percentage of the usable land value.

Lease values for dry land properties generally range between 5% and 9% of usable land value.

Of course, this again varies depending on the type of farm land you’re dealing with, whether the land is irrigated or can be used for livestock production.

Can I sublet the whole premises?

Yes, in some cases, you can if you can reach an agreement with your landlord.

However, in most cases, an “assignment” is usually required.

“Assignment” is the legal term for when a tenant transfers their entire interest in a commercial property to another person.

For example, if you signed on for a 3-year lease but decided to leave after the first year, you could get another person to take over the lease.

In order to go ahead with the assignment, you need to notify the head lessor.

You can simply prepare an assignment in writing with the help of your solicitor that stipulates who you are and who you will be assigning the lease to.

This should be signed by all the parties including the landlord.

What about my bond?

Under the Retail Leases Act 1994 and the Agricultural Tenancies Act 1990, your security deposit will sit with your relevant state’s bond board until such time that you vacate the premises and the landlord is satisfied that the property has been made good.

Even if you have sublet the entire premises to a third party, your bond will continue to be retained by the head lessor.

If you’re intending to vacate the premises, the bond will only be released once you have transferred the leasehold to the new tenant and the new tenant has paid the equivalent bond to the head lessor.

Do you need a commercial loan?

Whether you need a loan to buy your own commercial property or business finance to help with your cash flow, we can help.

Call us on 1300 889 743 or complete our free assessment form to speak with one of our specialist mortgage brokers.