Many CFO’s and Treasurer’s have recently been contemplating renegotiating their lines of credit well in advance of existing maturities in response to tightened credit markets with the objective of securing sufficient liquidity for the next coming years. The phenomenon has been labeled “amend and extend”. Dependant of the individual’s outlook for availability and pricing it seems decisions are relatively split between those willing to pay some additional spread now to lock in dry powder versus those who believe that the credit markets return to functionality is under way and prefer to wait versus paying the higher pricing.
A similar but opposite phenomenon exists in the commercial real estate market. As identified in the Congressional Oversight Panels report on “Commercial Real Estate Losses and the Risk to Financial Stability”, the current commercial real estate market is experiencing the most difficulty since the early nineties. Increasing vacancy rates and falling rental prices are presenting considerable challenges for landlords and lenders of commercial real estate. On average across all property types, values in the U.S. have declined about 40% since the peak in 2007. In addition, $1.4 trillion of commercial real estate loans are maturing between now and 2014 and nearly half of those are presently under water.
As a tenant, these existing conditions make the cash flow from your tenancy more valuable today than prior to the financial crisis and ensuing economic recession. As such, many companies are employing a strategy the industry refers to as “blend and extend” which takes advantage of these conditions to generate lower rental expense today while extending the term as an offset to the landlord.
As previously mentioned, rental rates have been falling since late 2007. It is probable that if your lease commencement occurred prior to the crisis you may now be paying above current market rates. The extent of the delta will be dependant on the market and submarket in which you reside.
Can I as a tenant reopen my lease with the landlord to take advantage of the current lower market rental rates and lock in longer term value? The following is a list of factors which could assist you in determining whether “blend and extend” represents a viable strategy to reduce your occupancy costs:
1. Time to lease termination – your existing termination date falls between the end of 2011 and the beginning of 2013. Any earlier and the current benefits from a reduced rate are diluted. Additionally, the landlord may not be convinced you have reasonable time to relocate to a project that would offer a lower market rental rate if they declined to open negotiations. Any further out and rental rates become more difficult to project lessening a landlord’s ability to make decisions.
2. Stabilized building occupancy – if your building has been subject to increased vacancy this puts a greater emphasis on securing the cash flow from your lease term and beyond.
3. Stabilized submarket occupancy – if there is a tenant flight out of your submarket to more desirable neighborhoods within your market this also will result in a greater value on your tenancy long term.
4. Your occupancy as a percentage of the project – generally, if your occupancy represents 10% or more of the project your tenancy can wield significant weight to the project and negotiations.
5. Existing debt on the building – if debt exists on the project, the landlord must insure coverage on the debt service or perhaps face default or foreclosure which will put greater value on retaining the cash flow from your lease.
6. Debt maturity between now and 2014 – as previously mentioned $1.4 trillion in commercial real estate loans are coming due between now and 2014. Many landlords will find it difficult to refinance during this period as loan-to value ratios will have fallen outside of loan parameters and stricter underwriting requirements have been put into place. The cash flow from retaining your lease becomes of greater importance.
7. Landlord’s future market outlook (Bear or Bull) - Ultimately, the landlords willingness to open the lease and renegotiate your rental rate may be dependant on the landlords personal perception of the speed and strength of the commercial real estate markets recovery which is generally known to lag the broader economic recovery in terms of the demand for space.
To the extent your landlord is willing to open your lease and provide for a lower current rental they will generally look for an extension to the lease term as an offset to providing this concession. This becomes the “extend” component. The medium to long term generation of value is derived from calculating the effective rental rate over the new lease life relative to the rate now in place. Negotiating the escalations therefore becomes a meaningful part of the strategy.
A similar but opposite phenomenon exists in the commercial real estate market. As identified in the Congressional Oversight Panels report on “Commercial Real Estate Losses and the Risk to Financial Stability”, the current commercial real estate market is experiencing the most difficulty since the early nineties. Increasing vacancy rates and falling rental prices are presenting considerable challenges for landlords and lenders of commercial real estate. On average across all property types, values in the U.S. have declined about 40% since the peak in 2007. In addition, $1.4 trillion of commercial real estate loans are maturing between now and 2014 and nearly half of those are presently under water.
As a tenant, these existing conditions make the cash flow from your tenancy more valuable today than prior to the financial crisis and ensuing economic recession. As such, many companies are employing a strategy the industry refers to as “blend and extend” which takes advantage of these conditions to generate lower rental expense today while extending the term as an offset to the landlord.
As previously mentioned, rental rates have been falling since late 2007. It is probable that if your lease commencement occurred prior to the crisis you may now be paying above current market rates. The extent of the delta will be dependant on the market and submarket in which you reside.
Can I as a tenant reopen my lease with the landlord to take advantage of the current lower market rental rates and lock in longer term value? The following is a list of factors which could assist you in determining whether “blend and extend” represents a viable strategy to reduce your occupancy costs:
1. Time to lease termination – your existing termination date falls between the end of 2011 and the beginning of 2013. Any earlier and the current benefits from a reduced rate are diluted. Additionally, the landlord may not be convinced you have reasonable time to relocate to a project that would offer a lower market rental rate if they declined to open negotiations. Any further out and rental rates become more difficult to project lessening a landlord’s ability to make decisions.
2. Stabilized building occupancy – if your building has been subject to increased vacancy this puts a greater emphasis on securing the cash flow from your lease term and beyond.
3. Stabilized submarket occupancy – if there is a tenant flight out of your submarket to more desirable neighborhoods within your market this also will result in a greater value on your tenancy long term.
4. Your occupancy as a percentage of the project – generally, if your occupancy represents 10% or more of the project your tenancy can wield significant weight to the project and negotiations.
5. Existing debt on the building – if debt exists on the project, the landlord must insure coverage on the debt service or perhaps face default or foreclosure which will put greater value on retaining the cash flow from your lease.
6. Debt maturity between now and 2014 – as previously mentioned $1.4 trillion in commercial real estate loans are coming due between now and 2014. Many landlords will find it difficult to refinance during this period as loan-to value ratios will have fallen outside of loan parameters and stricter underwriting requirements have been put into place. The cash flow from retaining your lease becomes of greater importance.
7. Landlord’s future market outlook (Bear or Bull) - Ultimately, the landlords willingness to open the lease and renegotiate your rental rate may be dependant on the landlords personal perception of the speed and strength of the commercial real estate markets recovery which is generally known to lag the broader economic recovery in terms of the demand for space.
To the extent your landlord is willing to open your lease and provide for a lower current rental they will generally look for an extension to the lease term as an offset to providing this concession. This becomes the “extend” component. The medium to long term generation of value is derived from calculating the effective rental rate over the new lease life relative to the rate now in place. Negotiating the escalations therefore becomes a meaningful part of the strategy.
Below is a simple test incorporating the factors. The more “Yes” answers you select may indicate pursuing this strategy could yield a meaningful return.
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