Hey, this is Matt Mellott with Sterling Commercial
Real Estate.
A question we’ve been getting recently is:
“how do I work with my tenants to provide
some near term help with rent without going
bankrupt in the process?
Most landlords want to help tenants that are
struggling. However, if rent concessions are
given en masse, it can create a cash shortfall
that devalues buildings and trigger widespread
loan defaults.
So, in order to keep tenants from breaking
their leases and to help preserve property
value, some tenants and landlords have agreed
to a change in lease terms called “blend
and extend.” This technique waives a period
of rent and then amortizes it out over the
life of the lease. In many instances, in order
for the payback period to be more manageable,
leases will also be extended past their original
expiration date. Other lease changes may be
made as well.
So, how does that work?
-First: talk to your bank about getting deferred
payments or interest only payments for a period
of time. 3-6 - 9 months. Anything that helps
reduce your debt service obligation will give
breathing room minimize the amount of cash
you need to keep everything above water. This
added flexibility for you as the landlord
should enable you to provide options for struggling
tenants. Also, make sure that your tenants
are availing themselves to all SBA programs
out there for help with payroll and operating
expenses.
Next, for tenants that are directly impacted
by social distancing and lockdown orders,
evaluate their lease. Talk with them about
their prospects for recovery after shelter-in-place
orders are lifted. Is a month of breathing
room that right amount of time? 2? 3? While
that may be hard to determine precisely, some
information on a tenant’s prospects is better
than totally shooting in the dark.
For this example, Assume that, after talking
with your tenant, a 4 month rent deferral
is the right amount.. also Assume also that
you were able to get a 4 month deferral on
mortgage payments from your bank. So How do
you defer rent payments without hurting the
value of your investment>?
Not to get too geeky (nerd alert) on this,
but if you adjust rent payments in such a
way that the net present value of your lease
remains the same before and after the doing
the blend and extend, you have accomplished
what you set out to do. You’ve helped your
tenant without hurting yourself.
What does that look like?
For sure sample, If you have a tenant that
was paying 5,000/mo with 4 years left on their
lease, the net present value of that stream
of income at a 12% discount rate is $186,768.50
The key to preserving asset value while also
preserving your tenant is to make the Net
Present Value of the lease the same before
and after modifying it to help the tenant’s
near term cash crunch. A couple ways to do
this:
1. Extend lease term. In this scenario, you’re
assuming that your tenant would have left
at the end of their term anyway. This is especially
useful for property types that tend to have
higher vacancy rates, such as office and retail.
To assist the tenant, you Can agree to either
an amendment to extend term, or have the tenant
exercise an renew option early if that’s
available in their lease
To equalize Net present value of the lease,
you may end up extending by 6 months on a
lease in exchange for four months of deferral
up front. That will depend on the discount
rate you apply to the lease and the remaining
term left on the lease when the rent vacation
is put into effect.
2. Blend the rent relief out by charging higher
rents on the tail end of the lease. You do
this by re-balancing the deferred rent amount
upfront throughout the remainder of the term.
I.e., if April, May, June and July are deferred
in 2020 at $5,000/mo in deferred rent , then,
take that 20,000 and re-balance it across
the remaining term of the lease. Keep in mind
that money collected in the future is worth
less than money collected now, so it’s not
as simple as dividing the deferred amount
by number of months remaining in the lease.
So, in our example, to make up for four months
of missed rent at $5,000/mo, and a 12% discount
rate, the tenant would need to pay $5,482
for the remainder of the lease term to equalize
present value.
3. Even after a rent holiday, some tenant
may not be able to hack a 10% jump in their
monthly rent right away. In this case, the
tail-end catchup period may need to involve
a “step-up”. In this scenario, rent might
be the same in the first few months after
the holiday is over. Then it jumps 5% over
scheduled rents for the next year, followed
by another 5% a year later. By doing so, you
weight the payback of lease payments later
in the term, in theory giving tenants a longer
runway to recover from shocks they’re are
experiencing today.
4. Blend and extend, which involves a mixture
of the three.
It’s important to note that blend and extend
can push some additional risk to you as the
owner by foregoing rent up front. If the tenant
defaults later, before the blended or extended
term is completed, then you man end up eating
that cost. You may also have unanticipated
legal expenses to write the modification to
the lease as well. For these reason, it may
not be a neutral NPV, but a NPV that brings
the owner out slightly ahead of where they
otherwise would’ve been to account for their
increased risk. Or, in some cases, it may
make sense for the landlord to renegotiate
purchase options, renewal terms, co-tenancy
clauses, etc, as a non-monetary way to balance
their risk.
When you talk with your tenants about “blending
and extending”,” using precise calculations
is important because it can be used to show
tenants that 1) you’re trying to help and
2) this is not a guess. For owners that have
debt on their properties, using precise figures
is also important when talking with your lenders.
Most loans come with covenants, including
debt coverage ratio covenants. If you’re
going to “blend and extend” with your
tenants, make sure your banker knows and can
see your math. T
I’ve mainly talked about dollar and cents
here. But remember: real estate is a team
sport in which relationships matter. Finding
creative ways to work together as partners
with your tenants is a relationship building
activity that usually benefits you in the
long run.Can you enforce your lease and put
a tenant in default if they don’t pay you
in April and May? Yes. Is that the best thing
for you in the long run? Maybe not.
This doesn’t work in all circumstances — not
all landlords are in position to do this.
Sad is it to say, there are tenants out there
as well that are capable keeping their lease
obligations who will take advantage of the
situation. But, there are plenty of times
where it does and it is worth your while to
explore creative options with your tenants.
We’re not attorneys or accountants, so consult
with one to help craft this. But, we are CCIMs
that understand how present value works and
how it plays into lease payments. By balancing
the Net Present Value of the property over
time, you can provide relief for a struggling
tenant without breaking the lease and without
crippling your asset value.
For help with calculating and negotiating
“blend and extend arrangements,” give
me a call at 406-203-3950 or email me here.
