What it means
The key structural point is that the head lease survives. If the subtenant stops paying, the original tenant still owes the landlord every dollar of the head rent, which is why a sublease reduces exposure but never eliminates it.
Most commercial leases restrict subletting, typically requiring the landlord's consent, which cannot usually be withheld unreasonably. Landlords care because they are being handed an occupier they did not choose, so consent often comes with conditions about use, alterations and the subtenant's financial strength.
The economics are usually unfavourable to the original tenant. Space is normally sublet because the tenant no longer wants it, which tends to happen when the market is weak, so the sublease rent is often below the head rent and the tenant carries the shortfall.
Accounting treatment follows that reality. Under current lease standards a tenant with an onerous sublease generally keeps the right-of-use asset and lease liability from the head lease, recognises the sublease income separately, and may need to impair the asset if the expected income falls short of the ongoing cost.
A related distinction matters legally. A sublease transfers possession for less than the remaining term of the head lease, while an assignment transfers the whole remaining lease to a new tenant, and only the assignment can potentially release the original tenant from future obligations.
In practice
Real-world examples
Example 1
A design agency that shifted to hybrid working sublets half its studio floor to a two-person architecture practice. The rent covers roughly two-thirds of the cost of the vacated area, and the head lease still has three years to run.
Example 2
A restaurant group closes an underperforming site with six years remaining on the lease. It sublets the unit to an independent operator at 80% of the head rent, accepting the shortfall as cheaper than paying a lease surrender premium to the landlord.
Example 3
A technology company that took a large office to accommodate planned hiring never reaches the headcount. It sublets two of five floors to another business, keeps the option to take the space back when the sublease ends, and avoids a permanent assignment that would remove that flexibility.
Think of it
Imagine renting a three-bedroom house for a year. After six months, you move abroad for work, so you rent two of the rooms to a friend. You still pay the main landlord every month, while your friend pays you.
Formula
Calculation
Net occupancy cost = head lease rent - sublease income
Sublease recovery rate = sublease rent per unit / head lease rent per unit
A professional services firm holds 20,000 square feet at $42 per square foot, so its head lease rent is 20,000 x $42 = $840,000 a year. After a restructuring it needs only 12,000 square feet and sublets the remaining 8,000 square feet.
The best offer available in a soft market is $30 per square foot, giving sublease income of 8,000 x $30 = $240,000 a year. The head rent attributable to that space is 8,000 x $42 = $336,000, so the recovery rate is $240,000 / $336,000 = 71.4% and the annual shortfall is $336,000 - $240,000 = $96,000. With four years left on the head lease, the total expected shortfall is 4 x $96,000 = $384,000, which the firm must recognise as a loss rather than spreading quietly across future years.
Even so, subletting is clearly the better option. Net occupancy cost falls from $840,000 to $840,000 - $240,000 = $600,000 for the 12,000 square feet actually used, an effective $600,000 / 12,000 = $50 per square foot, compared with $840,000 / 12,000 = $70 per square foot if the surplus space sat empty.Case study
Seen in the real world
The following is an illustrative and entirely fictional example. Ardley Consulting, an invented professional services firm, held 20,000 square feet at $42 per square foot under a lease with four years still to run, a commitment of $840,000 a year. After a restructuring the firm needed only 12,000 square feet and had no realistic prospect of growing back into the rest.
The landlord quoted a surrender premium of $700,000 to take back the surplus 8,000 square feet, which the board found difficult to justify. Marketing the space instead produced a subtenant at $30 per square foot, or $240,000 a year, well below the $336,000 the firm was paying for it and reflecting a market with plenty of vacant floors.
The finance director set out both numbers plainly. Subletting locked in a $96,000 annual shortfall, or $384,000 across the remaining four years, against a $700,000 surrender cost, and it cut net occupancy from $70 to $50 per square foot on the space actually used. In this illustrative case the board chose the sublease, recognised the $384,000 as an impairment in the year of the decision, and treated the episode as a lesson about signing for space based on a hiring forecast.
Watch out
Common mistakes
- Believing a sublease ends your liability. The original tenant remains fully responsible under the head lease, including for any rent the subtenant fails to pay.
- Signing a subtenant before obtaining the landlord's written consent, which can breach the head lease and, in the worst case, give grounds for forfeiture.
- Granting a sublease that runs to the very last day of the head lease, which in some jurisdictions converts it into an assignment with quite different legal consequences.
Questions
People also ask
What is the difference between a sublease and an assignment?
A sublease keeps the original tenant in the chain as the subtenant's landlord, while an assignment transfers the lease entirely to a new tenant and can release the original tenant from future obligations.
Can the landlord refuse consent to a sublease?
Usually only on reasonable grounds, such as concerns about the subtenant's covenant strength or an incompatible use, and most leases say so explicitly.
How is the shortfall on a loss-making sublease accounted for?
The expected excess of head lease cost over sublease income is generally recognised as an impairment of the right-of-use asset when the decision is made, rather than being spread across the remaining term.