A core misconception about commercial real estate leases stems from the belief that a lease term is permanently fixed and prohibits interim action by tenants who seek to restructure real estate expenses. For any number of reasons, a tenant may come to find themselves in a situation where they are leasing space at a premium to the market. This most commonly arises after a market correction or simply due to scheduled base rent increases and accrued expense escalations. Situations like these can leave a tenant who was otherwise paying a “fair market value” for its space subject to premiums of 10%, 20% or even 30% above current market pricing.
One tactic utilized by many proactive companies is the strategic early negotiation of extension term often referred to in the industry as a “blend and extend” transaction.
This name derives from the action of extending a lease’s term in exchange for the opportunity to blend down the P&L rental rate on what amounts to a new long-term lease obligation. The following example (Figure 1) displays a situation where “Tenant X” originally signed an 11-year lease in 2013 where the combination of term, base rent, free rent and tenant improvement allowance ("TI Allowance") resulted in a GAAP (straight-line equivalent) rent of $71.12/SF over the term of the lease. By July 1, 2021 (8 years into the lease), we assume that Tenant X has incurred operating expense and real estate tax escalations of $10.00/SF, which when added to the GAAP rent, lead to a full current P&L rent of $81.12/SF. You will note that the correlating cash expense for this lease is currently $98.00/SF due to base rent increases and expense escalations.