Seize the moment!—today’s weak office market presents a prime opportunity for tenants to secure favorable deals. Recent headlines of office buildings selling at discounts of 70% or more have many savvy tenants thinking, how can we capitalize on this trend? Many tenants, particularly those under long-term leases that were negotiated pre-COVID, are paying rent above market and/or have excess space. While some tenants may not have their lease expiring anytime soon, they may be able to capitalize on market conditions through a “Blend & Extend” negotiating strategy. In this post I outline this strategy and how you may be able to employ it while the market is in your favor. Thanks to Genny Emerson for her insights from representing Chicago office landlords for over 30 years.
Office Market Conditions:
As new office construction has ground to a halt and while more businesses are mandating a return to office, we are starting to see market conditions stabilize. In fact, in Chicago and other major markets, there’s a growing scarcity of premier office space particularly for larger users. Yet the market remains tenant favorable for most users. While the window of opportunity varies among markets, prudent tenants can be proactive in managing their costs and space options.
Blend & Extend:
- What is it? As the name suggests, the strategy is to extend the lease term in exchange for a reduction in rent to the current market rate as well as incorporating additional concessions including giving back excess space. That rate is blended into a new rental rate over the term. In addition to extending the term, tenants may also have negotiating capital in their lease. For example, tenants may be able to “horse trade” lease options (i.e., termination) in exchange for rent reduction and other concessions. The success of this strategy is driven by multiple factors including building vacancy, building debt, the tenant’s relative size, and tenant’s remaining lease obligation. Generally, the longer the remaining term, the more challenging it will be to successfully implement this strategy.
- Pros to Tenants? An early extension will allow you to reduce occupancy costs to today’s lower rates and shed any excess space. In addition to rent reduction, this strategy can also achieve other objectives in terms of obtaining monies from the landlord for space renovations which could include furniture and technology upgrades. It also creates an opportunity to revisit certain lease provisions that may be more tenant friendly, i.e., eliminating or limiting relocation rights, etc.
- Cons to Tenants? The biggest downside to tenants is the loss of flexibility. As changes happen more rapidly to businesses today, a longer lease term increases the risk that the space, in the long term, will not benefit the tenant. Flexibility provisions can be added to the lease to allow for contraction and expansion. Termination rights may be a challenge as it negates the primary benefit to the landlord of term extension.
- What’s in it for Landlords? Put simply, it can increase the building’s value. Thinking of an office building as a bond, its value is based upon cash flow and term. By extending a lease term, it helps boost the building’s value. It also can help a landlord refinance its debt which remains very challenging in today’s debt market.
How To Implement
- Hire an Experienced Tenant Rep Broker – As every lease and market is unique, tenants should hire a tenant representative broker who is experienced in the market, your building, and has a firm understanding of office leases.
- Analyze Your Lease – Review your lease (including all amendments) with your tenant representative and attorney to identify points to negotiate. Are there provisions that you can “horse trade” to incentivize your landlord to reduce your rent and offer other concessions? For example, do you have an early termination right that you can waive in consideration of rent reduction and other concessions? Have your tenant representative provide a financial analysis of your remaining lease obligation.
- Look Under the Hood – Research your current building including its debt structure, cash flow, and building tenant lease expirations. In other words, assess the landlord’s vulnerability and determine if a lease extension would be beneficial.
- Leverage the Market – Research the market for competing landlords that would entertain a future relocation based upon your timing and remaining lease obligation. If there are competing landlords that would be interested in your tenancy, it would enhance your negotiating capital.
- Negotiate – Kick-off negotiations with your landlord led by your tenant representative. To serve as the blueprint for negotiations, develop a detailed RFP of key deal points. To avoid being blindsided at the last minute, assess if the landlord’s lender needs to obtain consent to any lease terms. If so, be sure to get their buy-in.
- Analysis – Have your tenant representative provide a detailed financial analysis of the lease restructuring from your perspective, but also from the landlord’s perspective. By looking at the deal from the landlord’s side, you can creatively formulate deal strategies. Consult with your accountant, as to possible accounting and tax implications.
- Lease Negotiations – Finalize all terms in a lease amendment. Use this as a vehicle to address any unfavorable lease terms.
While not all tenants will be able to employ this Blend & Extend Strategy, given the depths of the office market, tenants should explore it, after all, nothing ventured, nothing gained.
Don Wenig
Blackacre Advisors LLC
info@blackacreadvisors.com
312-345-4778
DISCLAIMER. Our writings are from a real estate transaction perspective and for informational purposes only. Nothing herein shall be considered legal, accounting, tax, or architectural advice. Please consult with the appropriate professional(s).