Built to Suit Leasing for Commercial Properties
In a built to suit lease, a developer builds a property specifically for the use of one tenant. Generally, a tenant will locate a developer who is willing to purchase or ground lease land (or already owns land), and is willing to engage in a built-to-suit transaction. However, in some cases, a tenant will purchase land themselves. In this situation, they might finance the construction of a building, sell it to an investor and lease it back from them in a sale-leaseback transaction. In either scenario, built-to-suit leases are generally long term contracts, often lasting between 20 to 30 years or longer. This gives the developer enough time to recoup their initial investment in the development of the property.
In most cases, the built-to-suit development process will begin with a RFP (request for proposal), in which a tenant requests bids from multiple contractors in order to compare and contrast their options. This will contain various details of the tenant’s desired building, including the size, design, desired move-in date, acceptable rental cost, and other, similar requirements.
The Benefits of Built to Suit Development for Tenants and Investors
Built to suit development has a variety of benefits for both tenants and investors/developers. For the tenant, built-to-suit transactions are ideal, because they transfer much of the development risk from the tenant to the developer, freeing up capital that the tenant can use to grow and operate their business. For investors/developers, built-to-suit deals reduce the cost and uncertainty of finding a tenant, as the tenant has already signed a long-term lease on the to-be-developed building.
Construction and Leasing Considerations for Built to Suit Transactions
Due to the additional time and risk of a built-to-suit transaction, there are additional considerations that must be factored into the process. In particular, potential built-to-suit tenants generally need to have strong financials and great credit in order to qualify (similar to credit tenant leases).
Additionally, there will sometimes be significant negotiations between the tenant and the developer as to how the building will be designed and constructed. Tenants will generally want a building to conform to their exact specifications, while developers will want to make sure to limit costs, as well as to ensure that the building’s design is generalized enough that they will be able to rent it to other tenants after the original tenant’s lease expires (or, alternatively, if the original tenant defaults on their lease). However, expectations vary from deal to deal; some tenants may be happy with a basic structure that they will enhance (i.e. a dark shell), while others will want a fully finished interior with high end lighting and expensive floors.
Built-to-suit lease agreements often include the ability for tenants to make change orders, but these will generally need to get the landlord/developer’s approval as to ensure they do not cause unreasonable cost overruns.
Tenant Deposits for Built to Suit Leases
Due to the additional risk of built-to-suit deals, developers may want a cash security deposit or a guarantee from the tenant’s parent company (i.e. a parent guarantee) in order to make it more likely that they will not attempt to back out of the agreement later. Conversely, a prospective commercial tenant will want to make sure that the developer/investor has sufficient experience with built-to-suit projects and the funds to deliver a finished building when the tenant needs it.
Timelines for Built to Suit Development
In a built-to-suit development project, time is of the essence, as the tenant often needs to move out of their previous location, and will need to use the new building to operate their business. In addition to determining the projected move-in date, a built-to-suit lease will also need to detail the point at which a building is complete enough for the tenant to begin paying rent.
Leasing agreements may also include a lease renewal option, which may need to be exercised a certain number of months or years before the end of the initial lease. Finally, certain tenants may want their leasing contract to contain an option to buy the property before their lease is up.
Commercial Financing for Built to Suit Projects
Many developers use traditional commercial construction loans for the construction phase of a project, and, upon completion, refinance their property with a bank, life company, or CMBS loan. However, there are often better options. Some credit tenant lease (CTL) lenders and specialized built to suit lenders are willing to offer construction loans that convert to long-term permanent financing. Especially in the case of CTL lenders, these loans will often offer lower interest rates and longer amortizations, increasing cash flow and putting more money in developers’ pockets.