May 5, 2021
What Is Build to Suit?
A build to suit lease is one where the property owner builds a new building to the leaser’s specifications in exchange for a long-term lease contract. These can also be organized as sales, where developers construct a new building to the specifications of either a direct buyer or a landlord who will lease to a tenant.
Developers are fully responsible for the costs of building and will remain in possession of the resulting construction. Leasers will enter into a long-term NNN lease where they pay all the costs associated with running the building, including property tax and insurance, and will usually be the exclusive tenants. The owner will still be responsible for any structural repairs.
Build to suit works well for industrial properties, franchises, and other real estate sectors that require specialized facilities. While tenants may not be able to find the right building already existing in the market, build to suit gives them the chance to have what they need for a consistent and predictable lease term.
Why Build to Suit Sells Well
Build to suit is a popular model in areas with high enough CRE demand. It works well as a property type for investors who want less risk upfront. Developers can work with prospective tenants to pick an ideal undeveloped property before purchasing it or signing any lease agreements.
While the developer will have to invest more upfront to construct on the undeveloped property, by that point they will have a tenant already secured for 10+ years after the building is ready. This surety is better than constructing a building in hopes of finding a tenant afterwards.
At time of uncertain tenancy, build to suit works well. For instance, CRE vacancy rates hit a peak in 2020, with some industries like retail hitting up to 20% vacancies and office vacancies reached 15%. Other CRE industries fared better, with multifamily vacancy rates at 8% and industrial at 10%. These are the national numbers. Some markets were better off and others worse.
Why do developers like build to suit deals?
- Guaranteed tenancy
- Use for undeveloped land
- Low capital investment until a lease is secure
How Build to Suit Sales Work
Developers have two options with build to suit sales. If they own land already, it’s more of a simple lease arrangement rather than a full sale. As the landowner, a developer may also sell the land to another developer who has a build to suit tenant lined up already.
If the developer does not own the land already, they can work together with the tenant to seek out an appropriate parcel of land to build on. This allows the tenant flexibility to work with any developer they please and choose land that’s best suited to their needs.
Rent and the terms of the lease itself will be negotiated by the tenant and developer. Generally, the cost of the rent will be based on how market rates and how much of a return the developer is looking to get.