In commercial real estate, sometimes a tenant will have a very specific set of requirements for their building or land. In this situation, a build-to-suit lease is often the best type of commercial lease for the job.
What Does Build-to-Suit Mean in Real Estate?
A build to suit is a type of commercial real estate lease in which the land owner agrees to construct a property according to the requirements of the lessee. The lessee agrees to lease the property once construction is complete.
With a BTS, the developer or land owner is financing all of the build out and construction costs for the client. Once construction is finished, the owner becomes the landlord, receiving monthly rent payments.
“Franchises like quick service restaurants, pharmacy chains, and other franchise models are the most common users of build to suit improvements,” said Adam Robbins, the Strategic Real Estate Advisor at Real Estate Bees.
Build to suit properties are also common “with organizations that have very specific use and timeline requirements for their new facility,” said Robert Lumley, Vice President of real estate at BLT Enterprises.
Lisa Tamayo, Vice President of Development at BLT Enterprises added, BTS leases are common “for companies that have specific design requirements to best facilitate their operations.”
How Does a Built-to-Suit Lease Work?
With a build-to-suit development, the tenant will usually sign a long-term lease agreement — typically 10 to 20 years — agreeing to lease the property for that length of time. Afterward, the tenant typically has the option to extend the lease.
Most build-to-suit agreements are freestanding, single-tenant net leases, or triple net leases. This classification means there is only one tenant. They are responsible for property taxes, insurance and maintenance or operating expenses.
The process of establishing a BTS development in real estate begins with a prospective tenant choosing a site for their property. Examples of freestanding properties are Starbucks, CVS and Walgreens. Sometimes developers have a portfolio of land clients can choose from. In other cases, prospective tenants will conduct research and find a plot of land on their own.
Once they choose the land, the developer or land owner needs to agree to the terms of the lease. Some terms to discuss are the length of the lease and the rental rate, all while taking into account construction costs.
After all the terms are agreed upon, the developer will begin to prepare building plans. They will apply for construction and zoning permits and finally begin construction. Lease payments usually begin after construction is completed.
Who Pays for a Build to Suit?
In most cases, the developer or landowner will establish a development timeline and pay for the construction costs, but there are also situations where this is not the case.
“Typically, the costs are paid by the developer, with economics that support the lease rate and market,” Lumley said. However, “when specialty improvements occur, these costs may need to be fully amortized over the initial lease term or funded by the user.”
Robbins added, “Sometimes, the landlord will just lease the land to the user to avoid construction risk. Sometimes, the landlord will build the improvements and ask for higher rents to take the additional risk. There are many ways to structure a BTS transaction.”
Advantages of Build-to-Suit Developments
For tenants, build-to-suit projects offer a number of advantages. Landlords, while having to put in a great deal of upfront costs, will also benefit in the long-run.
The main advantage of a build-to-suit development is the ability to customize a property. The building will be built to the tenant’s exact specifications, from size, to appearance, to layout and more.
Tenants “are able to assemble a competent development team before any work commences,” Lumley said.
Less Upfront Capital for Tenants
Another advantage for tenants is that a build to suit lease doesn’t require upfront capital for that custom construction. In other situations, if a tenant wants a customized property, they would either have to buy a plot of land themselves, or do a sale-leaseback transaction.
A sale-leaseback transaction involves buying a property, paying for construction of the building, then selling it to a landlord once construction is finished. This arrangement requires a great deal of money upfront, which a build-to-suit lease does not.
For a tenant, making lease payments on a business property is 100% tax deductible as a business expense.
For a tenant, having a new property is preferable to an old one because the building will have fewer problems and maintenance issues. With a triple net lease, maintenance is the responsibility of the tenant, so a new property will certainly cut down on costs.
Predictability and Stability for Landlords
With a build-to-suit lease, landlords are guaranteed a long-term tenant. Although the landlord is paying for construction costs, they know that in the long-run they will receive a fixed amount of rent for at least 10 to 20 years. For landlords, many of the advantages are the same as those advantages of single-tenant net leases.
Disadvantages of Build-to-Suit Commercial Properties
Despite all these advantages, there are a few disadvantages to consider for both the tenant and the landlord.
Longer Commitment for Tenants
With a build-to-suit lease, tenants must be ready to commit to a property for at least 10 years. These leases are often long-term. For some tenants, this can work out well. But depending on market shifts and business success, long-term leases like this could be detrimental. For this reason, it’s a good idea to talk to a financial advisor before committing to anything.
High Upfront Costs for Land Owners
Build-to-suit leases usually require the landowner or commercial developer to put in all the construction costs, which can be quite high to start. While these costs are eventually offset with regular lease payments, landlords do need a good amount of upfront capital.
Complications Arise When a Tenant Leaves
If a BTS property is developed for a specific tenant, then that leads to challenges if and when that tenant chooses to leave.
“If the original tenant leaves,” Robbins said, “it may be difficult to find a replacement tenant willing to take the space, or it may require a significant investment to re-purpose the space for another use.”
How to Find Build-to-Suit Construction Financing
There are a number of ways to secure financing for a built to suit construction. Robbins suggested looking for finance companies that specialize in BTS leases.
“Most seasoned commercial mortgage brokers will be able to assist investors in securing the best financing options,” Robbins said.
Tamayo added, “Financing for build-to-suits is plentiful, as long as you have a credit tenant, a long-term lease and a building design that is not too unique.”
Build-to-Suit Leases Are Good for Long-Term Tenants
If you’re a property owner looking for a long-term tenant and don’t mind putting in some upfront construction costs to meet that tenant’s requirements, a BTS lease could be the way to go. As always, though, it’s best to speak to a financial advisor before taking the plunge.
Build-to-Suit (BTS) FAQs
How Long Does a Build-to-Suit Take and What Is the Timeline?
New construction can take up quite a large chunk of time. The timeline for a build-to-suit lease is usually around 15 to 24 months, sometimes 24 to 36 months depending on the difficulty of the property specifications.
What Is a Reverse Build-to-Suit?
In a reverse build-to-suit lease, the tenant acts as the developer. In this case, the tenant is in charge of construction. This is with the landlord’s approval and at the landlord’s expense. Reverse BTS leases are more common when the tenant has their own real estate or construction department. They usually still prefer to lease rather than own the property. In a reverse BTS, the landlord is also protected from additional costs outside of what was agreed upon.
What Is the Difference Between a Ground Lease and a Built-to-Suit Lease?
The primary difference between a ground lease and a build-to-suit lease is that in a ground lease the tenant leases the land, rather than the property. In a build-to-suit, the tenant is only leasing the building constructed on the land.