Creative tenant solutions: The blend-and-extend

One of my former co-workers just put this online.  He’s based in Ottawa but we do the same thing for clients here in Toronto.

As vacancies rise and commercial real estate rates begin to fall in Ottawa’s west end, some companies may grow frustrated about being unable to take advantage of a newly favourable market. So I thought I’d discuss a strategy that might be of interest: the ‘blend-and-extend.’

A blend-and-extend is when a tenant, typically with a few years of remaining lease term, signs an early renewal agreement with the existing landlord to add a few more years to their current lease. Usually this is done for one of two reasons: to achieve a lower rental rate today, or secure financing from the landlord to offset future construction costs.

In both cases, the rental rate on the additional term is blended into the existing rate to create a new ‘blended rate’ often lower than the original.

The mechanics of a blend-and-extend are relatively simple to understand. Let’s imagine a 15,000-square-foot company has two and a half years left on its office lease, and is paying $30 per square foot, in a market where the rental rate for a new lease has dropped to $25. Using simple math, if that tenant extended its lease for an additional two and a half years at $25 then the new average, or blended, rental rate would be $27.50.

This would represent an immediate reduction of close to $100,000 spread over the original two and a half years.

Executing a blend-and-extend, however, can be very challenging and depends heavily on timing and reading the market. How do you know market conditions are right? How do you convince a landlord to go along? When is the right time to bring it up? It all depends on the situation.

Indeed, the Kanata office market is an interesting place right now. In the midst of its current high vacancy rate, take note that many of the newer buildings were built between 1999 and 2001 for large users whose leases will roll over in the next two to three years.

Additional large blocks of space may turn over very shortly, creating a certain degree of risk for local owners. This opens the possibility for creative tenant solutions like a blend-and-extend.

The best part is if you aren’t able to negotiate enough of a savings, you already have several years of lease term remaining and have lost nothing but time.

In the context of a falling market, tenants can look at things from the landlord’s perspective and identify a positive rationale for the owner to go along. Perhaps having your firm extend by a few years will eliminate some upcoming risk in their portfolio that you might leave. Ottawa’s commercial real estate is predominantly owned by institutional organizations like insurance companies and pension funds that are very risk-averse, who might be open to this type of idea.

If they aren’t, in a few years they may have to compete for your tenancy on the open market and have a better chance of losing you to a competing building. Showing them how to eliminate that risk could be very appealing.

If your firm is planning major renovations or a sizable purchase of expensive equipment that’s expensive, or even impossible, to move then a blend-and-extend might be a good solution. Spending major, non-recoverable dollars in someone’s building is a clear sign that you aren’t likely (or able) to move at the end of a lease. Thus, a savvy tenant should take preventative measures, such as a blend-and-extend. Otherwise, they may find themselves without any real leverage come time to renegotiate the rent.

A successful blend-and-extend requires a lot of work and a high degree of market intelligence. Tenants must have a good idea of their landlord’s current bottom line, or they are setting themselves up for a failure before they even begin. Do your homework. Talk to other tenants in the building or in the business park to get a sense of where the market is heading.

Are there any big leases expiring close to your own in your landlord’s portfolio? Will they be eager to lock down your tenancy or will they be happier to wait a few years in hopes that the market recovers? This is information you must have because, rest assured, your landlord is a local market expert and certainly takes the time to stay informed – it’s their job. n

Darren Fleming is a senior adviser/broker for GVA Devencore Worldwide.

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