Over the years we’ve seen many companies struggle to efficiently manage what they have reluctantly had to sublease. Specifically, the ability to capture revenue on space being carried at a loss, OR, the time and energy required to assure compliance while also driving a primary real estate strategy, becomes inefficient at best or gets lost at worst. A few unfortunate realities lurk in the assumption that having a subtenant is one way to save variable occupancy costs and possibly partially neutralize a losing situation. Unfortunately, subletting starts with the best of intentions but gets lost in an organization more geared toward LESSEE rent expense than LESSOR rental income. There are a lot of challenges that come with managing a (sub)tenant, whether that tenant was unintentional when you leased the property, or as with healthcare companies, in cases where the tenant is an intentional part of a master let or owned property.
The Unintentional Subtenant:
Most companies are not equipped to deal with subleases…so they lose money on them in the first place and then what’s worse, they fail to collect all they could collect b/c they don’t have a good system for functioning like a landlord. What is automatic for a commercial landlord or landlord agent (things like having a good system for billing, tracking, collecting and posting accounts receivable, measuring the excess space and filtering and researching obligations between the Landlord and Tenant) becomes an ever-increasing list of missed opportunities and follow up tasks that are difficult to prioritize.,
The Intentional Subtenant:
If you Master Lease or own the property for operational purposes (or even sometimes as a Franchiser) you have an intentional income lease, but all of the same challenges and tasks mentioned above. For healthcare companies with tenants inside the hospital or medical office buildings there is also a requirement to maintain an arms-length relationship between Landlord and Tenant. For these Landlord oriented situations, the rental income has an even greater impact on the financial performance of the portfolio and the business operation So how do you make sure that you’re running an effective property accounting function and able to keep up with the proforma that likely justified the Master Lease or Purchase?
Whether the (Sub)Tenant was intentional or unintentional the goal is to establish an efficient process for managing the economic and strategic obligations inside the lease. This is something that Lease Administration and Property Management Companies can do extremely well because they have the people, process and technology geared for doing this already. With 20+ years of history managing thousands of (sub)lease relationships, we have found that these basic steps ensure that things run smoothly:
- Make it someone’s responsibility: Leaving it to the business group who gave up or leased the space is a sure way to miss opportunities and never really know where things stand.
- Thoroughly abstract the (sub)lease documents: There needs to be a clear and concise resource to detail the various obligations (administrative, accounting and otherwise).
- Make sure to link the Prime Lease and Sublease: Ensure that obligations are reconciled between the two contracts and that when you have an expense in the Prime Lease, it flows as appropriate to the sublessee.
- Considering shared or allocated expenses: Often parking, security, cleaning, other amenities or even utilities are overlooked because they are not parsed out but were intended to be shared in monthly billings.
- Send monthly invoices and make systematic collection calls: Uncollected sublease revenue, late fees and managing delinquency can get out of control quickly and create legal headaches and costs or compliance risks.
Best Practices Suggestions:
- Program Implementation – Create and manage a disposition program with both the underlying Prime Lease portfolio and the resulting subleases. This ensures sublease “revenue” is maximized and is recorded properly when billed and collected.
- Lease Abstracting/Management – Ensure that the proper data is extracted from the Prime Lease and Sublease and are appropriately linked, ensuring obligations are reconciled and managed between the two contracts.
- Sublease Abstracting – Sublease abstracts should contain new clauses like required insurance and maintenance that might not have been part of the Prime Lease Abstract because now you are managing the lease from a Lessor’s perspective.
- Database Implementation – Assembling the data and documents efficiently and uniformly into a database that can make the management and billing/collection easy is a great way to leverage available technologies.
- Financial Review Financial Review – If the sublease has been in place for some time, it can make a lot of sense to reconcile past activity and investigate unpaid balances. We have recovered millions of dollars that went undetected previously.
- Routine Billing & Collection – Based on obligations in the sublease, as well as, obligations implied by the Prime lease, mail a monthly invoice to the subtenant and direct payments a lock-box location. Track payment receipts and route as appropriate. Make sure that your collection activity includes late fee billing, collection calls, and coordination with legal counsel if defaults go beyond an agreed period of time.
- Reporting – All database change activity and accounting activity should be reported monthly, in both summary and detail, for real estate and accounting or compliance review.