When a Blend & Extend Strategy Makes Sense
A Blend & Extend is a transaction where a tenant offers up an extension of term for a blending of rent on the remaining and extended portions of the lease term. Typically such transactions take the form of a blend-down of “above market” rents or a “blend-in” of additional leasehold improvement dollars in exchange for additional years of term. The tenant benefits by securing the premises, usually a lower rent and/or other financial or non-financial benefits (i.e. more capital now from the landlord to alter premises vs. waiting until expiry). The landlord gains the security of the company’s tenancy well in advance of the expiry date.
This process can be complicated. Due diligence is required prior to approaching the Landlord with any offer.
Let’s look at 4 common conditions that create a situation where a Blend & Extend Strategy may make sense for a tenant:
The Tenant Likes the Space – To consider an extension of term, the tenant needs to be happy with the space. The macro elements of the building and location need to work, and the existing space should be able to accommodate growth plans, recruitment and retention concerns, etc. Simply put, the Tenant should be able to consider the space, either in its current condition or as remodeled or expanded/contracted premises, as a long-term home.The Tenant’s Needs For Space Change – More often than not, during the term of any lease, a tenant’s requirements for space will change. Space needs grow and shrink with any business . . . space layouts become obsolete with new standards.. furniture gets old . . .and new management seeks more efficient/better ways to work. Tenants do not need to wait until the lease expires to deal with such changes. Landlords are often willing to negotiate and accommodate tenant’s changing needs in exchange for term commitment and/or removal of tenant existing rights that are not desirable for the landlord (i.e. an outstanding early termination right, right of first refusal on a floor of space for another tenant, surplus preferred parking, broad exclusivity right, etc.). If a tenant has something the landlord wants, they should be willing to negotiate.Losing The Tenant Would Be Bad For The Landlord – When market vacancy (or building vacancy) rises, landlords typically negotiate to secure existing tenants well in advance of lease expiries. Economic uncertainty and rising vacancy brings opportunity for tenants to re-evaluate and improve upon existing lease terms, including rent. In short, a “tenant’s market” allows tenants to negotiate from a position of strength – revisiting the lease and renegotiating terms while three, five or more years of term remain on the tenant’s current commitment is not uncommon.The Tenant or Landlord Wants/Needs Something – Sometimes, the conditions for a Blend & Extend are about securing rights that are non-financial in nature but equally or more valuable to the tenant. Tenants may want building signage rights after the departure of a previous anchor tenant, or additional parking, or rights of expansion for project space in anticipating of winning a major contract. By offering the security of an extension of term, the conditions to secure such benefits may be optimal — the perfect opportunity to open up the lease and ask for the moon.
This is not a complete list of drivers for when a Blend & Extend strategy could make sense a tenant. Each situation is unique and needs to be evaluated as such.
Does it make sense for tenants in the Greater Toronto Area (GTA) to consider Blend & Extends?
Yes and no. It depends on the situation and the landlord.
In general, the GTA office market is dominated by institutional and pension fund ownership that is traditionally risk averse and conservative in nature. They are sophisticated landlords with access to all the tools, legal expertise and market intelligence required to negotiate effectively. Approximately 2/3rds of all vacancy in our market is listed by the landlord itself (or their asset/property manager), supported by an experienced personnel.
Sample of our major landlords include:
GWL Realty (asset manager for Pension Funds)Bentall Kennedy (asset manager for Pension Funds)Dundee REITOrlando Corporation (private developer, mostly of industrial properties)Manulife (insurance)HOOPP (pension fund)Mix of mid market private investors from Canada, US or overseas
Here’s the position we’re seeing from some of these landlords on the street:
1. Orlando (Private): A dominant landlord in our market like Orlando has experienced shrinking vacancy and positive absorption across its portfolio. Rates are bound to go up with vacancy in its office portfolio estimated at sub 7%. Our Team recently represented Chartwell REIT in a Blend & Extend Strategy with Orlando. The tenant had 3+ years of remaining term, but we were able to achieve a blend down of the net rental rates, resulting in a substantial savings for a 70,000 sf tenant. The landlord won too by securing a longer term with a solid, financially stable and happy tenant, thereby reducing risk of a large vacancy in the future.
Takeaway – ensure you have a strong understanding of the local market in the GTA from an advisor with a track record dealing with the landlord.
2. Dundee (REIT):
Dundee REIT is the largest of the REITs with a large portfolio of office properties in our market. They have a near monopoly position in some sub-nodes, like the Airport node NW of Toronto. Dundee is unlikely to agree to a blend down of rents having recently acquired many of their suburban buildings at high prices. However, they will negotiate other aspects of a deal for an expanding tenant. For example, to accommodate an expanding tenant such as SNC Lavalin in their West Mall portfolio, they were willing to do reasonable transactions to relocate smaller tenants for SNC. When we represented Yardi Systems in the early part of 2012, White Rock REIT (since acquired by Dundee REIT) was willing to provide large allowances for improvements, however, was very resistant to lower the rates for the remaining lease term.
Takeaway – with a large REIT, it’s essential to understand its motivations relating to the valuation of their assets and any pending acquisition or disposition motivations. Armed with such knowledge can provide clues as to how much and where/when they would be willing to consider a Blend & Extend negotiation with a tenant.
3. Manulife Financial (Institutional / insurance):
Manulife is another large, sophisticated landlord in our market. In Mississauga, they own an A-class, three-building complex that is facing major competition with several new LEED office buildings constructed in the last few years nearby. Manulife’s portfolio has Additional Rents well above new product and has experienced a loss of large tenants, such as Intact Insurance, recently. In our opinion, the conditions are ideal for existing Manulife tenants to consider a Blend & Extend.
We recently represented a tenant of Manulife’s in a Blend & Extend negotiation: Manheim Corporate – Auto Auctions. Manheim had several years of term remaining and was paying $x.. psf/yr above market. It was also experiencing growth as a result of an acquisition. With a proper tenant rep process and due diligence, we were able to qualify that a neighbouring tenant no longer needed its space, and in fact, had interest in getting out earlier. We put together a proactive strategy to expand Manheim into that space while blending down the rent with Manulife.
Takeaway–it’s easier to secure a Blend & Extend with a secure, expanding tenant. And being proactive before the lease expires can identify opportunities.