There are two common options for commercial tenants looking to eliminate excess space: subleasing or a lease buyout — each with cash, balance sheet, and P&L impacts that must be understood to achieve an optimal financial outcome.
What Is a Sublease?
When a commercial tenant executes a sublease, the tenant rents out a portion or the entire space to another tenant. The original tenant remains responsible for paying rent to the property owner but collects rent from the subtenant to offset the obligation. A sublease can have a positive impact on cash flow, but the tenant's lease liability remains unchanged on the balance sheet.
Balance Sheet Treatment
Under ASC 842, the Right of Use (ROU) Asset is reduced by the expected loss — calculated as the present value of the remaining head lease obligation less the present value of sublease income. Any tenant improvement assets are written off at the time of cease use.
P&L and EBITDA Treatment
A write-off/impairment of the expected loss is recorded at the time of cease use. After the write-off is recognized, the straight-line rent expense of the head lease is less than the sublease income, which produces a net gain and reduction of EBITDA over the remaining lease term.
A sublease does not erase the liability from the balance sheet — but it can significantly reduce EBITDA impact once an impairment is recognized.
What Is a Lease Buyout?
When a buyout is executed, the liability is eliminated from the balance sheet. A lump sum payment to the landlord ends the lease early. The payment is recorded as a one-time expense, and the liability drops to the P&L. At the time of a buyout, a gain or loss is observed by finding the difference between the ROU Asset and the Lease Liability on the balance sheet.
When a Buyout Is Worth It
An early buyout makes sense if the buyout fee is less than the NPV of remaining lease payments at a discount rate reflective of the tenant's cost of capital. The buyout strategy also becomes more favorable when a company is undergoing significant financial transformation — reducing liabilities can significantly influence company valuations during M&A activities or pre-IPO.
How to Compare the Two
| Factor | Sublease | Lease Buyout |
|---|---|---|
| Cash impact | Positive (subtenant income) | Negative (lump sum) |
| Balance sheet liability | Remains (with impairment) | Eliminated immediately |
| EBITDA | Improved post-impairment | One-time hit, then clean |
| Ongoing risk | Subtenant default risk | None after execution |
| Best for | Cash-sensitive companies | Pre-M&A or IPO companies |
The Deal Structuring Dimension
What most companies miss is the structuring dimension — the timing of rent abatement, the front-loading of recovery, and the interplay between the sublease income stream and the head lease obligation can be engineered to target specific accounting outcomes. In one recent transaction, we structured a sublease where rent abatement was pushed 18 months out and rent was front-loaded, maximizing near-term cash recovery for a client facing a pending business disposition.
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