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Wins & Insights

Tenant Leasing Illustrated – May 2014 – The “Bracketology” of Assignment and Subletting Profit

The “Bracketology” of Assignment and Subletting Profit

My brother Mike heard from a surgeon friend that the Monday before the beginning of the NCAA’s “March Madness” basketball tournament is the biggest day of the year for male elective surgeries among married men.

That’s right. A little inconvenience like having your knee replaced or your gall bladder removed and then you have the perfect excuse to lie on the couch guilt-free and watch four days of non-stop college basketball.

I kind of get it. For me the tournament is the greatest “black hole” for my free time, other than “Game of Thrones” reruns or practicing my high frequency electronic trading algorithms (okay, I am only kidding about the reruns).

It is astounding that I can watch five minutes of East Boise State against Albuquerque Technical College, suddenly care who wins, and then miss my needed beauty sleep to see what happens.

Not surprisingly, the tournament is an economic bonanza, with a television contract worth an amazing $10.8 billion. The networks, cable stations, universities, and coaches all make millions, and the “student athletes”…

Oh yeah. They get relatively nothing, even though their play generates the revenue.

Don’t ask me why, but this makes me think of how landlords require that they share in the profits when a tenant assigns or subleases its lease.

In most leases, if a tenant wants to assign or sublease, it must first offer the space back to the landlord. If the landlord does not choose to “recapture” the space, and the assignment or sublease meets certain criteria, the tenant can assign or sublease.

Most leases also provide that, in such event, the landlord is entitled to some (or even all) of the “profit” from such assignment or sublease.

The method of calculating such “profit” will determine whether or not there is anything left over for the tenant.

A tenant may argue that, during the term of its lease, it should control the space and the landlord should not share in any profit.

But landlords will say that the landlord is in the business of real estate, not the tenant, and the landlord should profit from the leasing of space in its building, even under an assignment or sublease by the tenant after the landlord has chosen not to recapture.

There is some validity to this landlord point of view, even though much like the collegiate hoopsters, any actual profit is being generated through the efforts of the tenant.

A proper compromise is for the tenant to cover all of its costs and then have the landlord and tenant share in the actual net profits.

Avoid costly turnovers (of profit) in your own assignment and subleasing transactions with these six suggestions:

  • Do not allow your landlord to take all the profits. Some leases provide that 100% (or some other amount greater than 50%) of the assignment or sublease profits go to the landlord. A customary and reasonable compromise is to split the net profits 50/50.​
  • Carefully define “net profits”. Before profits can be divided, the parties need to define what actually constitutes net profits. Net profits mean the actual aggregate consideration received less the aggregate costs incurred.​
  • Narrowly define consideration. ​

○​   Assignment profit and sublease profit include all sums actually paid to you for such assignment, or rent received for such sublease, including sums paid for the sale or rental of leasehold improvements, furniture, fixtures and other personal property.​

○    Consideration with respect to such leasehold improvements, furniture, fixtures and other personal property should be reduced by either the fair market value of such property or net unamortized cost of such property with respect to a sale, or its fair market rental value with respect to a rental.​

  • Broadly define costs to be boxed out from consideration. ​

○  Typical exclusions include brokerage commissions, legal and other professional fees, advertising costs and transfer taxes.​

○  Make sure to also include costs to ready the space for your assignee/subtenant, such as build-out costs, tenant improvement allowances and “free rent” and other concessions offered to subtenants.​

○  Try to deduct costs incurred in carrying the space while vacant (including rent paid to your landlord). Your landlord will push back to limit this to a reasonable marketing period (e.g., 60 or 90 days).​

○  Look to exclude the unamortized costs of your build out of the premises (less any costs attributable to a landlord work allowance). Landlords often resist this exclusion and your ability to obtain it will depend on your leverage in the transaction.​

  • Deduct your sublease costs up front. You should try to claim all of your deductions at the beginning of any sublease when the costs are incurred. The “profits” to you are only on paper until actually received so the costs should be calculated as they occur.​

Landlords often push to have the costs amortized over the term of the sublease. If you must agree to amortization, at least try to include an interest factor on the unamortized balance.​

  • Do not share the profits until realized. Many profits splitting provisions define profits on the basis of the rent “payable” (as opposed to “paid”) under a sublease. Some landlords will even look to receive a one-time payment of the calculated profits with a discount factor. You should share with the landlord only if and when you actually receive net profits. Particularly with a subtenant, payments are to be made over time and you always run the risk that your subtenant could default.​

Gearing up for next year’s tournament, there will be countless married men conducting inventories of available body parts for elective surgery. Follow the suggestions above and, at least when it comes to assignment and sublease profits, you will not lose an arm and a leg.​