By: Kristy DeSmit | June 17, 2014
In commercial real estate, business tenants sublet or assign space as a way to transfer rental rights to help with leasing costs and avoid being penalized for ending their commercial lease earlier than a fixed term allows.
Whether a company has simply outgrown its office space or cannot make ends meet, transferring lease rights to a third party may be their only solution to fulfill the obligations of their tenancy.
Laws regarding subleases and assignment vary by state or region. Some states do not allow any form of transfer unless the landlord consents. For this reason, it’s important to understand your options and if you are legally entitled to transfer a lease according to your state law, your landlord and your lease agreement.
Here is how subletting differs from assigning a lease, including the steps involved with each and which alternative is best for your company’s commercial work space.
A sublease means to transfer a portion of your rental rights to a third party for a temporary period. You can either sublet a portion of the space, while you resume work, or lease the entire rental unit temporarily until you return.
Let’s say you run a seasonal business for eights months of the year, but you are signed onto a two year fixed lease term. If your landlord consents, you may sublet the property for four months of the year to generate income to pay rent until you return. The original (master) lease still stands during this period between you and your landlord, but you are now responsible for a new tenant. Typically, they would pay you rent directly and go to you with any issues concerning the rental property. The full details of your relationship would be dictated in a sublease agreement.
Subleases are an increasingly common trend for big box stores who lease corners of their facility to smaller retail locations, or similarly with startups who don’t have much capital and prefer to cut real estate costs by sharing an office with other entrepreneurs.
Steps to Sublease
Subletting a commercial property shares a similar process to assignment, yet both transfer methods have very different outcomes. Below are the steps involved with subletting a commercial rental space from a tenant’s point of view.
1. Refer to your commercial lease agreement. Before you can consider subletting your office or warehouse space, you must refer to your commercial lease agreement to see if there is a clause stating your rights to do so. Often, there will be a term detailing your rights to transfer a leasehold. It may require you to get written consent from your landlord. If there is no clause stating the landlord’s policy on subleasing, consult with your landlord about the option.
2. Provide notice. Depending on your state, you may be required to provide advance notice to the landlord that you are transferring rights to another renter. If your lease clearly states your ability to transfer, adhere to the notice time mentioned.
3. Find a tenant. If possible, screen tenants until you find a suitable renter. Because you are liable for their tenancy, it’s vital to make sure they have a reliable and credible renting history.
4. Draft and sign a commercial sublease agreement. Once you have found a trustworthy prospect, you must draft a commercial sublease agreement to address the terms of their tenancy. You are now referred to as the sublandlord, and the new tenant becomes the subtenant.
Like mentioned, the master lease still stands between you and your landlord, but you are now responsible for the subtenant’s tenancy. While most of the terms in the sublease will mirror the lease, the sublandlord has flexibility in determining several aspects, such as rent/utility price, insurance, damage deposit, improvements, lease term (automatic renewal and fixed), property purpose, inspections and any other additional clauses. Discuss the terms of the sublease with your landlord to ensure he/she approves.
For arrangements that involve subletting a portion of commercial space, ensure the space is clearly described in the sublease.
Sign the agreement with the subtenant and restate the terms to confirm their acknowledgement and understanding of the tenancy.
5. Carry out sublease. As the sublandlord, you are legally liable for the subtenant. They will pay rent to you and any damage caused their tenancy is your responsibility. It is your authority to uphold all the terms in the sublease.
If the subtenant requires a repair, they would contact you to take care of it. It would then be your job to approach the landlord for remedy. Essentially, there is little to no legal relationship between the subtenant and landlord.
Pros to Sublease:
- You are able to quickly transfer partial rights of property to save money on rent expenses and keep yourself in legal boundaries of not breaking a lease term, or having to pay out the remainder of the lease.
- You get to be flexible in your sublease contract
- If you are sharing a space, you may have the benefits of shared resources or customers, networking, reduced carbon footprint, and workplace diversity.
Cons to Sublease:
- You may be adding to your workload by managing a tenant, in addition to your own landlord-tenant relationship.
- It’s temporary and you are legally liable for the tenant should any damage or lease violations occur.
Assignment of Lease
Assigning a commercial space means to transfer the remaining interest of your lease to a third party.
If your business needed to downsize because of loss of profit, yet you were locked into a fixed term with no option to sublease part of the space, you may have the option to assign the lease over to another tenant if your landlord gives you permission. Contrary to subletting, you do not plan to return to the space. After you have assigned the lease to a new tenant, the landlord must release you of financial obligations via writing in order for you to be free of any future liability. Otherwise, you may be held responsible if the third party does not adhere to their obligations.
Steps to Assignment of Lease
Similar to subletting in the initial stages, an assignment of lease can hold very different outcomes. Here are the steps to assigning a lease. Please note it may differ depending on your location.
1. Refer to your commercial lease agreement. Like a sublease clause, there should also be a statement on the original commercial lease addressing whether a tenant can assign the remainder of a lease to a third party. You may have to seek written consent from your landlord. If there is no clause, consult with your landlord about the option to assign your lease over and provide notice of assignation.
2. Find an assignee. The new tenant is called the assignee and you are the assignor. As assignor, you have passed over your rights of the tenancy to the new tenant. In most cases, they will be held to the same terms as the original lease.
3. Sign a lease assignment agreement. Draft a lease assignment to hand over your rights to the new tenant. It will include the terms of the assignment and may include a copy of the master lease.
4. Liability and release. Although you have assigned your interest in the commercial rental space over to the assignee, you may still remain responsible for the performance of the property to some degree, unless the landlord offers you a release from all contractual and financial liabilities. This means if the assignee does not fulfill his or her obligations, you can be liable for their negligence.
5. Assignee assumes possession and interest. At this point, the assignee is the new tenant and would deal directly with the landlord as they would have had they been a new tenant without the assignment.
Pros to Assignment of Lease:
- If your business is in dire need of relocation, downsizing, or you’re simply unable to pay your rent, assigning can relieve you of your lease rights.
- You do not have to manage a subtenant, as they will be in direct contact with the landlord.
- If released, you incur no liability for the assignee.
Cons to Assignment of Lease:
- You assign all lease rights over to another tenant, which means you may not return to the space during that time.
- If you have not been released by the landlord, you may still be liable for the new tenant.
Which to choose: Sublease or Assignment?
It’s important to remember that the decision to sublet or assign a commercial property remains with the landlord. Generally, they prefer stability and knowing who their tenants are. However, landlords may be willing to allow a transfer if your business is experiencing a dip in revenue and you need to assure that the rent will be paid on time, and in full.
Discuss transfer options with your landlord prior to signing a commercial lease. It can come in handy to have that option pre-approved should you need to transfer lease obligations over permanently or temporarily in the future.
If both options are available to you, weigh each with careful consideration.
Temporarily transferring some of your rights may be the best course of action if you are seeing slow sales, taking a vacation, or need to sublease a portion of office space to meet rent until the lease is up.
Keep in mind, a sublease arrangement requires more work on your part as the tenant because you are essentially keeping your existing arrangement and adding another one on top of it. This means you take on some responsibility as a sublandlord. It also means you can designate the sublease terms, so long as they do not contradict or override any boundaries in the master lease.
Conversely, assigning a commercial space may be the better option if you simply cannot pay your rent and need someone to take over the lease immediately. Just note that this may not completely free you from liability as you may still be responsible if the assignee falls through.
As a tenant, the correct choice will ultimately depend on your current situation and needs. You will not only want to weigh the benefits of each form of transfer, but also weigh the consequences and reliability of the third party. Your rental history as a business may be affected by the outcome of your tenancy, therefore be sure to think through this decision as it could end up affecting your future rental potential and credit.
Have you ever transferred a commercial lease by subletting or assignment? How about sharing office space? We’d love to hear your personal story in the comments below!