In changing times, blend and extend lease transactions can benefit both tenants and landlords.
WITH THE STANDARD office and industrial lease term lasting five to 10 years, tenants have little flexibility to adjust their leases as their businesses or the market change. Tenants can, however, use a strategy referred to as “blending and extending” to realign their real estate commitments to changing business or market conditions.
In a blend and extend transaction, a tenant’s remaining lease term (usually one to three years) is extended and the current rental rate is “blended” with a newly negotiated one. The primary driver of blend and extend leases is change. As Steve Steinmeyer, a managing director with JLL, points out, “Changing conditions create the potential for these deals. If a tenant’s or landlord’s situation has changed, this is definitely a structure that can make sense and can be a win-win.”
Tenants most commonly use the blend and extend strategy to lower their rental obligation. Ed Clark, an executive managing director in Newmark Grubb Knight Frank’s (NGKF’s) Washington, D.C., office, explains that the strategy is most feasible in markets with “above average historical vacancy rates and high concessions packages, where landlords don’t see the situation improving in the short term.” In the context of the Washington office market, blend and extend may still be viable in the suburban office campuses of Northern Virginia and Suburban Maryland that are not well-served by mass transit.
Tenants can also use blend and extend to negotiate changes to their leases like expansions or contractions. According to Clark, “In today’s marketplace, tenants are trying to decrease their overall footprint and become more efficient through densification. They go to landlords to blend and extend, and give back a portion of their space.”
While blend and extend is more prevalent in soft markets, tenants may also pursue these types of leases in strong markets as a way of hedging against rising rental rates. Roman Adler is a senior managing director in NGKF’s San Francisco office, where vacancy is just 4.6 percent and the average rental rate has doubled over the past five years. “Certain tenants are trying to take advantage of the fact that they see continued growth in the market and they’d rather transact in today’s market than two years from now,” he notes. “On the landlord’s side, sometimes that’s music to people’s ears because they are more conservative and they like transacting in what they view as a good market, even if there is more room for growth.”
For landlords in any type of market, tenant retention is the primary motivation for agreeing to blend and extend. Clark explains that a landlord could be willing to lower a tenant’s rate early: “If the landlord looks at where the market is today and doesn’t see that the market is going to significantly improve over the next few years, it justifies their willingness to lock in a tenant while they still have a captive audience, rather than let that tenant get close to lease expiration and consider a move.”
Several other factors may play into a landlord’s willingness to blend and extend. Clark notes that a building’s lease expiration schedule can incentivize a landlord: “If they see the majority of their building expiring in the next few years at around the same time, anything they can do to spread that out, they’ll consider.”
David Kluth, an executive managing director for NGKF in Los Angeles, expands on that: “A landlord might have some debt maturing that might make them more flexible or be willing to do something early. They also might have a plan to sell the building.” Additionally, certain types of risk-averse landlords like REITs and pension funds may be more inclined to blend and extend than risk a potential vacancy.
It is hard to make broad generalizations about blend and extend transactions, because so many factors influence their feasibility. According to Adler, “It all depends on the specifics of your existing obligation and the market.” Steinmeyer adds that blend and extend transactions “are very specific to a situation and they could make sense for one tenant in a building and not make sense for another tenant in the same building in the same market.” However, for tenants who have done their research and fully understand the market as well as their building and landlord, the blend and extend strategy can be a powerful tool for addressing change.