Commercial real estate is on its head. Here in Australia, vacancy rates have hit record highs, and landlords are carving out concessions to attract and retain quality tenants.
With every leasing deal, there's a chance to set a new bar. It's a great time to be a tenant and an even better time to explore potential savings scenarios.
But how can tenants who are already locked into a lease benefit from the current market?
Enter the 'Blend and Extend' (a.k.a the mid-term negotiation), a strategy which can help tenants with multiple years remaining on their lease negotiate lower face rents, improved incentives or limit liability on their remaining lease tail.
"Blend and extend" is an industry phrase that means extending an existing tenant's lease and "blending" the rental rate they are paying with a newly negotiated rate and/or terms. It can also be referred to as a "mid-term" lease negotiation.
Landlords can improve the value of their commercial property in one of two ways:
The chances of a landlord negotiating higher rents in a soft market are unlikely, so we will focus on vacancy.
Vacancy is costly for landlords in any market. But in today's climate, Landlords will go to lengths to avoid them and guarantee their income for a longer term, even if it means accepting less rent.
That's because the flight-to-quality trend is strong across all market sectors. Quality fitted space is becoming more affordable and is popular amongst tenants looking to entice their staff back to the office and attract and retain talent. More and more landlords are undertaking speculative fit-outs to make the flight to quality more attractive, pushing up the vacancy for lower-quality spaces. The amount of quality fitted subleasing stock has also surged as larger tenants adopt hybrid working models and look to get rid of excess space. This means Landlords have more competition and higher vacancy risk. And this forces them to inject CAPEX into their assets, re-forecast their pricing expectations or enter mid-term negotiations with sitting tenants to retain them for a longer term.
Even in a market with lower vacancy rates, a Landlord may still benefit from a mid-term negotiation if a few of the tenancies within their portfolio are expiring concurrently. In this case, a blend and extend can push back some of those lease expiration dates by a few years, reducing their risk and increasing the length of their WALE.
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Let's say a commercial tenant signed up for a five-year lease at $900 psqm for a 1,000 sqm office space (a.k.a $900,000 per year) and has two years remaining on their lease.
Now say this tenant is looking to reduce costs and knows that vacancy within the building and in comparable spaces has reduced the current market rate down to $800/sqm. In this case, the Landlord may agree to "blend and extend" the lease for another five years, allowing the tenant to pay a reduced rate of $850 for the remaining two years of their current lease and allowing them to pay the current market rate of $800 for the next five years of the new lease.
Here, the tenant would save $50,000 per year over the remaining two years of their lease, generating a total savings of $100,000 over two years and locking in attractive rates for a further five.
Of course, Landlords are opportunistic. So, they'll be unlikely to agree to a lower rent unless they believe that rents will stay the same or fall over the extended term. However, this is not the only scenario in which tenants can use this strategy. It's also possible to use a Blend and Extend approach to negotiate mid-term incentives or concessions from the Landlord, including:
The bottom line? If the negotiated rent or terms benefit both parties, there's a good chance your Landlord will go for it.
There are a few pros and cons to consider when it comes to the mid-term lease negotiation:
This strategy will be most successful if:
In a soft market, Landlords risk their space sitting vacant for months, even years. Incoming tenants will also likely ask for larger incentives than renewing tenants to help offset their relocation costs and help them build out their new space.
So, you’ll need to approach your Landlord and demonstrate how the deal you’re proposing will leave them in a more favourable position in the long term than if you were to:
To quantify these two-way savings and create negotiation leverage, tenants need to canvass the market and genuinely explore the idea that they will not renew their lease.
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The market is depreciating and becoming more competitive, which means higher vacancy, lower effective rents and higher incentives. Landlords are struggling to compete and are more flexible than they have been in years. And this is the perfect storm for opportunistic tenants.
Conducting a market search and considering other feasible options can give you leverage at the negotiating table. But the landscape is not easy to navigate alone, even in a tenant's market. There's more to negotiate, and tenants need access to the whole market to get the best deal.
Most commercial tenants are still making poor lease deals because:
So, if you're considering tackling a mid-term negotiation, you need an experienced team in your corner representing your interests.
Tenant CS is an independent tenant representation company here to ensure you're never left in the dark again. We take the time to get a thorough understanding of what you need from your space, conduct a full market search (so you're across every option), work with you to figure out the best-fit property for your business, and negotiate on your behalf, so you get the best deal.
Get in touch with our team today to see how we can help you with your mid-term lease negotiation.
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