What it means
Picture a company that rents a floor of an office building for five years and decides it needs only half of it. It sub-leases the spare half to another business, which makes the company a tenant to the landlord and a landlord to the sub-tenant at the same time.
That middle position is the sandwich. Property investors and operators sometimes create sandwich leases deliberately.
They take a long lease on a building or a serviced space, improve it or divide it up and then let it out in smaller pieces at higher rents. The profit comes from the spread between what they pay up the chain and what they collect down it.
The structure carries real risk. The middle party owes the head rent whether or not the sub-tenant pays, so a vacancy or a defaulting sub-tenant comes straight out of its own pocket.
It also needs the head landlord's consent in most cases, and the head lease terms must allow sub-letting. Timing is the other point to watch.
A sub-lease normally cannot run longer than the head lease, and a break or expiry in the head lease can leave the sub-tenant with no home. Careful operators align the dates and write the sub-leases so that they fall away when the head lease ends.
In the accounts the middle party applies lease accounting to both sides. It recognises its own head lease as a liability and a right-of-use asset, and its sub-lease as income or a receivable, depending on the standard and how the sub-lease is classified.
The details differ between accounting frameworks, so specialist advice is sensible for larger arrangements. Lenders and landlords look closely at these structures.
A head landlord may refuse consent if the sub-tenant is risky or the use is unsuitable, and a bank financing the middle party will test whether the sub-lease income can cover the head rent with room to spare.
In practice
Real-world examples.
Example
A flexible-workspace company leases an entire floor for $40,000 a month and lets desks and small offices to start-ups for a combined $55,000 a month. Its $15,000 monthly spread pays for staff, furniture and cleaning.
Example
A retailer closes a store but is still committed to the lease for three more years. It sub-lets the unit to a smaller shop to recover part of the rent, becoming the middle party in a sandwich.
Example
A property trader takes a long lease on a warehouse at a low rent, splits it into six small units and lets them to local businesses at higher rents, aiming to pocket the difference.
Formula
Calculation
Monthly Spread = Rent Received from Sub-Tenant - Rent Paid to Head Landlord
Annual Net Income = Monthly Spread x 12 - Vacancy and Other Costs
Worked example: a fictional serviced-office operator pays $20,000 a month in head rent and sub-lets the space for $26,000 a month. It budgets for $18,000 a year of vacancy and fit-out upkeep.
Monthly Spread = $26,000 - $20,000 = $6,000
Annual spread = $6,000 x 12 = $72,000
Annual Net Income = $72,000 - $18,000 = $54,000
Over a five-year term the cumulative net income would be $54,000 x 5 = $270,000, assuming rents and costs stay as stated.Case study
Seen in the real world.
Greenline Workspaces is an illustrative, fictional company that took a ten-year head lease on a tired office block at $30,000 a month. It spent $240,000 refurbishing the building and sub-let it to twelve small tenants for a combined $42,000 a month.
In the first two years all went well and the spread of $12,000 a month more than covered the refurbishment. Then three tenants left in the same quarter and monthly income dropped to $33,000, leaving a spread of only $3,000.
Because Greenline still owed the full head rent, the shortfall came out of its own cash. In this illustrative story the lesson was to keep reserves and stagger sub-lease expiries so that one wave of departures cannot wipe out the margin.
Watch out
Common mistakes.
- Assuming the sub-tenant's rent is guaranteed, when the middle party still owes the head rent if the sub-tenant leaves or defaults.
- Granting a sub-lease without checking that the head lease allows it or that the head landlord has consented.
- Letting a sub-lease run longer than the head lease, which can leave the middle party in breach.
Questions
People also ask.
Who is the sandwich in a sandwich lease?
It is the intermediate tenant, the party who leases from the owner and sub-lets to the end user.
Is a sandwich lease the same as a sub-lease?
A sub-lease is the lower layer, and the sandwich is the overall arrangement viewed from the middle party's position.
How does the middle party make money?
From the spread between the rent it collects from the sub-tenant and the head rent it pays, less any vacancy and running costs.
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