February 25, 2021
A build-to-suit (BTS) lease arrangement is when a landlord builds a new construction to match a specific commercial tenant’s requirements. Properties involved tend to be ground up developments lead by the needs of the tenant, but fully funded by the developer.
In this case, developers are not building a property to sell it to an eventual landlord. Instead, the building is constructed for the specific purpose of being leased to a pre-named tenant.
Characteristics of a Build to Suit Deal
BTS leases are usually arranged as triple net leases, meaning the tenant is responsible for all costs associated with the property, minus large structural repairs. This is ideal for landlords who want a passive investment.
Tenants entering into a build to suit deal have to commit to a long-term lease. The minimum is usually 10 years, but it’s common for these leases to go up to 15 or 20 years.
Because of the nature of build to suit leases, the tenant has no or low upfront costs while the owner takes on the longer-term risks of property development and ownership. Landlords end up with full ownership of the property as well as a stable long-term tenant while tenants take on less financial risk while still having use of a property that’s perfectly suited for their business.
Depending on the developer’s existing land portfolio, tenants may choose to have the building constructed on one of the properties already held by the developer or on a newly purchased property. Generally, the tenant and developer will work together to select a suitable property.
Who Uses BTS Leases?
BTS leases can be beneficial for both the tenant and the developer under the right circumstances. These are the parties who are most likely to enter into a BTS agreement:
- Tenants who would receive unfavorable rental/mortgage interest rates
- Tenants without the capital required to construct their own facilities
- Tenants with specific operating requirements that are difficult to accommodate in existing CRE spaces
- Tenants looking for tax benefits in the form of fully deductible rental payments
- Tenants who want to reinvest capital into their business rather than their facilities
- Developers seeking stable rental income from a long-term client who is highly likely to renew their lease
- Developers diversifying their portfolio
- Developers who want a passive CRE investment
Examples of Build to Suit Leases
Build to suit leases are more common in some market sectors than others. While the model is not necessary for businesses who can easily adapt to any space, there are particular industries that often take advantage of BTS leases.
There is some overlap between the types of businesses that utilize build to suit leases and those using sale-leaseback agreements. The difference often has to do with the business’s access to capital and developer interest in the project.
Companies that open many different branches need to be able to expand rapidly into new, unfamiliar market areas. They also have a specific playbook for their facilities that outline the visual and functional specifications for each location.
These businesses may not have the initial capital required for so much new construction over a short period of time.
While large, established manufacturers may have access to large amounts of capital and credit, smaller manufacturers looking to expand or new manufacturing companies may utilize build to suit in order to get the facilities they need at a lower upfront cost.
Certain medical facilities have specific construction needs that may not be well-met in their target market areas. In this case, a medical service provider may enter into a built to suit agreement.
With the expansion of the medical real estate sector, these deals are not as likely in larger markets as developers may already be catering to the specific needs of medical facilities.
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