Amending Commercial Leases in Response to Recessions
By Richard Mallory
During and following the recessions of the early 2000s (March 2001 to November 2001) and The Great Recession (December 2007 to June 2009), commercial tenants utilized a process of negotiation with their landlords that allowed them to immediately reduce their fixed and additional rent in consideration of extending the length of the Terms of their leases. This negotiation process, commonly referred to as “blend and extend” has had a resurgence due to the current COVID-19 Recession (February 2020 to present), whereunder commercial tenants can realign their real estate commitments to reflect changing business and market conditions. The process (referenced herein as the “Blend & Extend Solution”), when successful, allows businesses to navigate their immediate lease obligations and lower their costs in the short term while continuing to maintain good relations with their landlords, who avoid possibly losing a tenant during times of increasingly higher vacancies. This combination can fairly be included in the general category of a “win-win” result.
The Blend & Extend Solution has the best chance for success when a combination of factors are present, which include that (a) the tenant desires to remain in the building in which it is currently leasing space, (b) the tenant’s then-current lease has one to three years of Term remaining, (c) the tenant’s financial condition is at a level where the landlord, all other things being equal, would be comfortable entering into a longer contractual relationship than the one that is shortly due to expire, and (d) the landlord and its lender have a significant preference for retaining the tenant in the building when compared with taking back the space at the end of the current lease Term and marketing it to a third party, thereby keeping the premises occupied and avoiding down-time and new tenant concessions (e.g., moving allowances, abated rent, initial tenant improvement costs and allowances and brokers’ commissions).
In analyzing how to structure a Blend and Extend Solution, the tenant’s representatives need to take care to consider all of the accounting ramifications on its balance sheet and income statement that stem from the decision about just how many months to extend the Term of the lease in consideration of the magnitude of the immediate rent savings during not only what remains of the then current term of the lease, but also during the first year or two of the extended Term. The tenant should call upon its financial advisors, or if necessary, retain outside financial advisors, to provide it with alternate scenarios that can improve rather than negatively impact its financials, and particularly its net income and its earnings before interest, taxes, depreciation and amortization results.
The degree to which the Blend & Extend Solution benefits the tenant in an amendment to the lease can go far beyond a lower rent during recessionary times, and can vary widely, examples of such benefits being (i) the right to contract its footprint to take advantage of the potential densification of its operations in the space, (ii) the addition of tenant perks such as free parking and additional or more prominent signage, (iii) receiving remodeling/retrofitting allowances, (iv) adding rights of first offer to lease space that becomes available during the extended Term, (v) adding the right of early termination at a favorable price, (vi) the elimination of owner-favorable rights such as the right to relocate the premises within the building, (vii) the resolution of outstanding lease issues such as what can be properly included in Operating Expenses or CAM and addressing any ambiguities in lease language, (viii) reducing or eliminating credit enhancements or guaranties, and (ix) (in retail space) the easing of use restrictions, lowering or elimination of percentage rent, and adding or enhancing co-tenancy provisions.
As long as that laundry list of tenant benefits may seem, landlords (particularly REITs and pension funds) and commercial building lenders are loath to experience vacant space, and the direct and indirect costs of such vacancies are difficult to exaggerate, with the direct costs including those described in clause (d) of the second paragraph above, and with the indirect costs being a reduction in the building value for both sale and refinance. Interestingly, the entire Blend & Extend Solution can work in both parties favor during boom times as well; tenants in a rising rental market who wish to remain in a building with specifications and in a location that work particularly well for the tenant, and facing a Term that may expire sooner than later, have been known to reach out to their landlord to request an immediate increase in their rent in return for an extension of the Term at a rate that the tenant believes will be less than what it will be facing when its Term expires; also a win-win result.