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The “Blend and Extend” Trade-Off Strategy

William Krueger • 17/03/2021

With commercial landlords facing a potential rise in vacancies, there is significant discussion around enticements that could be offered to tenants in order to retain their occupancy. One such deal type is a “Blend and Extend” lease restructure, in which tenants renew their lease early across an extended length in return for certain concessions from the landlord.

To succeed, a Blend and Extend lease restructure must contain advantages for both the Tenant and the Landlord. Typically the “win-win” could involve an immediate rent reduction from the landlord in exchange for a longer-term lease commitment by the tenant. The landlord trades off a lower rent today in exchange for the security of a longer lease term.

Chances for success are best when:

  1. There are 12-24 months remaining on a fixed-term lease or at any point during a standard Japanese lease
  2. Current rents being paid are above fair market value
  3. The tenant is comfortable in the space and would be happy to remain in the premises longer-term at a fair-market rent

Blend and Extend Restructures in Practice

Let’s look at an example using Tokyo office building “Y” with rents expressed in JPY/net rentable tsubo(“nrts”)/month. Most of the leases in Building Y were signed several years ago at an average of JPY36,000/nrts/month. The prevailing fair market rent in the current market is JPY30,000/nrts/month.

As a firm, the building owner recognizes that market rents in the building have dropped due to prevailing conditions. With many leases set to expire in the next 12 months, the building owner is keen to retain existing tenants and avoid protracted vacancy and lease-up costs in the property. Longer-term the owner remains optimistic about recovery in the rental rates in the property.

Tenant X has been in the property since the building was completed, and has 24 months still remaining on a 60 month fixed-term lease on which it pays JPY36,000/nrts/month. While its longer-term business prospects in Japan remain bullish, in the short-term Tenant X’s business and cash flow have been hard-hit by the pandemic, and it is seeking immediate cost savings. It is however realistic about the fact that it has a binding lease in place at higher rents, and is seeking a compromise solution.

Both landlord and tenant may benefit by the Blend and Extend proposal structured by a tenant property advisor such as Cushman & Wakefield. Such an agreement could be structured as follows:

  • The current lease term would be extended by 24 months.
  • Rents for the entire lease term would be reduced, including both the 24 months remaining on the current term plus the 24 months extension, to JPY32,000/nrts/month effective immediately, down from JPY36,000/nrts/month.

The Benefits of a Blend and Extend Restructure

Under the cooperative “win-win” solution, the tenant agrees to remain longer-term in the property. Both landlord and tenant avoid the costs and risks of the tenant relocating. The revised rental structure reflects the market more realistically, and the tenant has achieved the immediate cost savings it desired.

A key to tenant negotiating leverage and successfully negotiating a Blend and Extend is that the current fixed-term lease term expires in the near future (12-18 months is ideal).

Alternatively, under the standard Japanese lease (vs. the fixed-term lease), the tenant has the unilateral right to terminate its lease at any time by providing 6 months prior termination notice. In such cases, in exchange for a rent reduction, the owner will require the tenant to convert to a fixed term lease, or add early termination penalty provisions to the existing standard Japanese lease.

In either case above, if the owner is not amenable to restructuring the terms of the current lease, then the tenant has the near-term leverage to relocate to alternative premises quickly, providing them with strong negotiating leverage.

Another key factor for the success of a Blend and Extend is that the office premises must suit the tenant’s needs reasonably well. I.e. the tenant must be comfortable remaining in the premises longer-term without serious constraints on head-count growth, or issues of technical obsolescence, etc.

Conclusion

A Blend and Extend lease restructure must be a “win-win” transaction. It requires realistic market understanding and realistic lease concessions by both landlord and tenant in order to succeed. Cushman & Wakefield adds value in this area.

An owner’s negotiating stance will depend on many factors including its immediate and longer-term market outlook, market situation of the specific office property under consideration, overall portfolio condition, competition for the tenant, and overall owner negotiating strategy.

Finally the “wins” for each side are not necessarily limited to the example given above - other types of concessions from the tenant perspective could include free rent, periodic “rent holidays”, tenant fit-out, or other items of economic value to the tenant.

For a cost-free analysis of whether a Blend and Extend solution could work for your situation, Contact Cushman & Wakefield today.

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