As the price of office space in the District soars, the growing practice of subleasing is turning into a high-rise goldmine for some long-term commercial tenants. And in a recent precedent-setting decision, a D.C. Superior Court judge said the tenants could continue to cash in on their good fortune without splitting the profits with their landlords.
Building owners who agreed to bargain-rate, long-term leases when the office rental market in the District was slack still may attempt to retrieve some of those subleasing profits, but the test case is believed to have dealt a severe blow to such efforts.
D.C. Superior Court Judge George H. Revercomb ruled last month that the Grocery Manufacturers of America Inc. may sublet part of the eighth floor of the Waterfront Center in Georgetown--formerly called the Dodge Center--for double the rent it pays the owner, 1010 Potomac Associates, and does not have to turn over any of the profits from the sublease to the landlord.
The ruling is likely to apply to many commercial leasing agreements throughout the District, local leasing experts say, because owners of commercial buildings typically gave tenants options to expand and extend their leases with few restrictions in the second half of the 1970s. Those leases generally run for 10 years with options to renew often negotiated at five-year intervals. Several local housing experts said there are large numbers of these unrestrictive leases throughout the city from that period.
When office vacancy rates began to fall several years ago, rents started to soar and building owners began putting strict subleasing restrictions into contracts. Those limits were not overturned by the Superior Court ruling.
But businesses that signed the earlier unrestricted agreements and now are moving or closing, or for other reasons no longer need as much space as they anticipated, may find they have a lucrative side-business in office space.
"The tenant is becoming a speculative landlord," said Tom Owens, vice president for commercial leasing at the Shannon and Luchs real estate company. "A lot more tenants are going to sublet for profit."
Joseph Moravec, vice president of Leggat McCall & Werner Co., a brokerage firm, called the court ruling "a blockbuster" and said that subleasing "has been a very successful approach for a lot of firms" to help them defray their own leasing costs.
"I've never seen so much sublease space on the market" as in the past four years here, Moravec said, adding that the space is of all kinds and sizes and throughout the city. For the next six months, subleasing may account for half of all the leasing in the city, he predicted, though after that much new rental space will be coming on the market.
The court ruling, apparently the first of its kind in the District, stated that the owners of Waterfront Center could not withhold approval of a sublease merely to enhance their own economic position. The subleasing clause in the original agreement with the grocery manufacturers said the association had to have the owners' permission but that it could not be "unreasonably withheld."
Legitimate reasons for withholding consent would include the undesirability of the subtenant or the subtenant's business in the building, neither of which were problems in the grocery manufacturers proposed sublease, the ruling stated. The subtenant in the case is a law firm, Seymour, Seefried and Hoffman, Chartered, and the building owners did not find fault with the firm as a tenant.
"Instead the owners seek solely to take advantage of an upswing in the real estate market and obtain now more rental than was bargained for in 1977 when the lease was made," Revercomb wrote. "The purpose of the subletting clause is to protect the landlord's bargain under the prime lease in question, not the landlord's general economic opportunities."
"Basically what the ruling said is 'a deal is a deal,' " said Mark Tuohey III of Nixon, Hargrave, Devans & Doyle, who represented the grocery manufacturers in the case.
Office rents in the District on the average have doubled in the past three years, housing experts say, while the vacancy rate has been near zero. A recent study by Kenneth D. Laub and Co. Inc., a real estate consulting and brokerage firm, predicted that prime office space rents in Washington would double again before the end of the decade.
"Since the market change, these landlords would love to see every older tenant move out of their buildings," said one commercial leasing analyst who asked not to be named. "It's strictly a matter of money."
Philip R. Carr, vice president of the Oliver T. Carr Co., one of the city's major real estate developers, said about the practice of subleasing for large profits that "obviously, we don't like it" but that there doesn't appear to be much the owners can do about the older leases. All of the leases his firm negotiated in the late '70s included provisions for recapturing the space if a tenant wants to sublease, Carr said.
Law firms are frequently mentioned as successful subleasers, and one prominent example is Covington and Burling. Covington and Burling recently moved from five floors of office space at 888 16th St. NW, owned by a subsidiary of the Motion Picture Association of America Inc., and leased out its space to a local Washington law firm.
While a spokesman for Covington and Burling declined to discuss the specifics of the leasing arrangement, other sources said that the agreement proved to be quite profitable for the law firm -- which had moved into the building in 1969 -- and that the new lease had become a point of contention between the law firm and the landlord.
As the commercial leasing market tightened at the end of the '70s, building owners started putting different kinds of sublease restrictions into contracts. These included ways of splitting subleasing profits, the right to limit subleased space, and first rights of refusal after an initial sublease.
Some large tenants still can negotiate favorable subleasing arrangements, but it is more difficult now, local experts said.
At the same time, the current low vacancy rate has meant that some tenants with favorable rights to sublease may themselves be looking for places to expand.
Sheldon Weisel of Shaw, Pittman Potts & Throwbridge, for example, said that in the past his firm has done some short-term subleasing of space but that "now the tables are turned and we are going to do some subleasing from other tenants in the building" at 1800 M St. NW, which is owned by the Oliver T. Carr Co.
Others, however, may find that changed plans or circumstances make subleasing a valuable option.
"Sounds like a good idea," said a member of a large investment firm when informed of the subleasing that had prompted the court suit. "Now I know what to do if the market goes crazy and plunges, and we have to shut down."