A Build to Suit (BTS) is where a commercial property tenant enters into an agreement with a developer or landowner to construct a new, custom-built facility for lease. Once completed, the tenant typically become the sole occupant. This type of agreement allows for optimally efficient use of both the land and the building as the future occupant specifies how they want it to be designed to meet their business needs. When you see Walgreen’s, standalone Starbucks, or many single-occupant office or warehouse buildings, those are often done as BTS projects. If companies as big as Starbucks, Amazon and Walgreen’s are doing BTS projects, there’s probably a pretty good reason for it.
How does it work?
BTS development is a dynamic process involving the negotiation of a lease and a construction contract simultaneously. Before we take a more in-dept look into some of the advantages and disadvantages of this type of transaction, lets first create the structure and timeline of how they typically work, as each deal is going to be different with varying needs and circumstances.
BTA developments usually come packaged in two forms:
1: Developer Route: The growing company elects to engage a commercial broker to “shop” their deal to commercial developers. The developer that offers the best deal then takes on the burden of acquisition of the land, construction of the building and management of the property. The Tenant then leases the property from the developer upon completion, usually for 10 years or more.
2: Sale/Leaseback Route: In this case, the Tenant assumes the initial burden of land acquisition, financing liability, and the hiring of the general contractor to plan and construct the building. Upon completion, an investor purchases the building with single-tenant remaining as the occupant. By doing so, the tenant gets all their acquisition capital back out of the building to re-invest into business as they see fit.
What is a typical Build-to Suit timeline? What are some advantages of Build-to-Suit?
– The developer usually secures the equity and debt for the project, which frees up capital for the tenant to use in the growth of their business.
– The design of the building will be tailored to the exact needs of the tenant with existing needs and future growth options in mind.
– If your company yields better than 10-12% on its capital deployed inside the business, you will likely make more money by being a BTS tenant than as an owner-occupier with capital tied up in a building.
– Rent for the tenant is fully tax-deductible* in most cases, consult your tax attorney or CPA.
What are some disadvantages of Build-to-Suit?
– The overall time frame of a BTS can reach out as far as 15-24 months, or longer in some cases.
– Tenants may view long-term lease deals as a drawback if adequate growth and contraction options aren’t available.
– New construction is expensive. BTS construction is no exception, you just pay for it in a higher lease rate.
– Creditworthiness is a must for tenants in a BTS arrangement.
– Mandatory that tenant has accurate forecasts of future and expected growth, assuring that their future needs are met in the design and construction of the new property.
BUILD TO SUIT VS REVERSE BUILD TO SUIT
As discussed above, a build to suit lease has various definitions. There are a number of different lease structures and unique elements that separate a build to suit lease from a standard commercial lease. The construction element is truly the backbone of the build to suit lease. But sometimes it isn’t always a simple “developer builds, tenant occupies” scenario. While we’re accustomed to a standard build to suit, there are other options. Lets’ take a look at what those are:
Build to Suit – The build to suit process entails all the steps necessary to select, acquire, finance, and lease a property that is custom built to the specifications of the occupant. With a build to suit lease, the landlord retains greater control over the development of its property and uses its existing knowledge of the site and local construction practices.
Essentially, a standard build to suit lease contains two agreements in one document: a lease agreement and a construction agreement. So, the focus of the entire build to suit development process is on issues and the most complicated, warranting close attention to the landlord’s and the tenant’s responsibilities in this regard. To simplify it, the landlord/developer will be responsible for constructing and the tenant will occupy and pay rent on the said building. The rent is based on a stated rate of return on imputed land value, plus a reasonable estimate of hard and soft costs of construction. In some cases, the basic rental rate may be subject to adjustment based on actual construction costs.
Reverse Build to Suit
In a reverse build to suit development, the tenant essentially acts as the developer. The tenant will construct its building upon the landlord’s approval and at the landlord’s expense. The method is sometimes preferred by a tenant who has their own real estate and/or construction department but still prefers to lease rather than own real estate. The landlord is typically protected from additional costs. Permitting, etc.
With the reverse build to suit lease, both parties benefit from the tenant’s experience in constructing virtually the same building in many locations. The tenant has complete control over the construction process and the facility is custom-designed by the user.
A third option might be to use a combination of build to suit to suit and reverse build to suit options. Typically, this method involves the landlord performing the site work and the tenant constructing the building. This option combines the landlord’s familiarity with the site with the tenant’s familiarity with its prototype building.
Wai-Yew Lam, Trec Instructor
Adelphi Retirement Management LLC