A build-to-suit lease is a leasing arrangement where a landlord and tenant, typically business owners, contract with a developer to build a property to their specific commercial needs.
The landlord generally does not bear the upfront costs of construction. Instead, the developer recoups their investment by leasing the property to the landlord after its completion.
This type of real estate lease is ideal for tenants that need a customized building to run a commercial operation. In addition, the commercial developer is usually responsible for providing raw land and designing and constructing the commercial building according to the tenant’s business needs.
What Is a Build-to-Suit Lease & How Does It Work?
In commercial real estate investing, a build-to-suit lease involves a property developer and landlord agreeing to lease a custom-built structure for a predetermined number of years. This arrangement allows a tenant to occupy a specially made property that meets their specifications without having to front the capital for construction themselves.
For example, a commercial enterprise that needs an office building with certain specifications may enter into a BTS lease with a development company that owns an undeveloped parcel of land. The company would work with the developer to build the office on the leased land.
Before construction, the length of the lease, monthly rental rate, and build-out requirements are negotiated. Then the tenant may proceed with the move-in and occupancy process once the build-to-suit development is complete. As a result, the developer is essentially guaranteed a tenant for their newly built property.
What Are the Different Types of BTS Leases?
Landlords and real estate investors can choose from several types of build-to-suit leases to secure commercial property. The most widely used long-term leases are from reverse build-to-suit to developer agreements.
A popular BTS lease among real estate investors, this type of contract involves a property owner and a lessee, in which the owner sells the property to the lessee, then leases it back from the lessee on agreed terms. The purchase price of the new building tends to be lower than the market value.
This is because the landlord is selling the built-to-suit property to the tenant, expecting they will lease it back to them. In general, sale-leaseback agreements are used to raise capital for various purposes, including business expansion, debt refinancing, and working capital, without the company having to take on debt.
Reverse Build-to-Suit Agreement
If the tenant serves as the property developer, this is a reverse build-to-suit lease. At the landlord’s expense and with their approval, the tenant is responsible for constructing the property on the provided plot of land.
Aside from the costs noted in the leasing contract, landlords are usually exempt from additional expenses, such as permits and architect and engineering fees. Tenants may prefer this arrangement if they already own real estate or possess the necessary resources to develop a property, such as through ownership of a construction or general contractor company.
Among the most common BTS leases, this agreement takes place between a property developer and a commercial entity with assistance from a broker. When the tenant requires a retail space that is not readily available on the open market, they may work with a developer to build a property to the tenant’s specified business needs.
Then the tenant may agree to lease the property from the developer for ten years or longer. In many cases, a developer agreement will give the tenant a few renewal options, such as extending the lease or purchasing the property outright at the end of the lease term.
How Does the Due Diligence Process Work for BTS Leases?
Before entering a build-to-suit leasing agreement, it’s vital to understand the due diligence process. This process helps protect both the lessee and the lessor by ensuring all relevant parties are aware of and agree to the risks involved in the build-to-suit projects.
While doing your due diligence, evaluate significant factors related to the property, such as the location, zoning regulations, and site availability. In addition, negotiate the lease terms with the lessor, such as the amount and schedule for rent payments.
Conduct a thorough review of the construction plans and specifications, inspect the site, and verify that all required permits have been obtained. The goal during this process is to make sure the property developer is meeting your standards and requirements.
What Are the Pros & Cons of a BTS Lease?
A developer build-to-suit leasing agreement is an effective way to operate a business from a new property without putting up all the money for the construction up front. For the tenant, a BTS lease guarantees that the property they are leasing will be built specifically for their business needs.
This means that the tenant can have a say in the design and layout of the property, ensuring it meets their precise requirements. On the other hand, the landlord’s developer benefits from a BTS lease by avoiding the hassle and expense of finding a suitable tenant for their property.
However, there are also certain limitations to be aware of when considering this type of lease. For one, a tenant may have to commit to leasing the space for a set period, usually a decade at minimum, which can be inflexible if their business needs change.
As a result, if the tenant decides to vacate the property before the lease is up, they may be required to pay a hefty penalty fee.
Plus, because BTS leases are often customized to the tenant’s specific needs, finding a new prospective tenant to lease the space can be challenging if the original tenant needs to move out before their lease is up.
Another limitation of a BTS lease is that the tenant is usually responsible for all repairs and maintenance costs on the property, which could prove costly in the long run. As for the developer, any cost overruns associated with the construction project could be their responsibility, depending on the lease terms.
How To Structure a BTS Lease Agreement
A build-to-suit lease functions as a construction contract involving the developer agreeing to construct a commercial space according to the specifications of the landlord and tenant. When structuring a BTS lease agreement with a developer, consider the following elements:
- The lease length: Usually determined by the time needed for the construction or renovation project. Develop a clear understanding of how long the project is expected to take, from commencement to completion, so no surprises occur down the road.
- The scope of work: From detailing an estimated timeline to establishing project milestones, clearly delineate the scope to ensure clarity about what is included in the agreement.
- The cost: Outline all construction expenses and other associated costs, such as permits and insurance, to stay within budget.
- The payment schedule: Clarify when lease payments are due and how they will be made (e.g., lump sum or monthly installments).
- The termination clause: Describe under what circumstances either party can terminate the agreement early and specify any penalties for doing so.
Additionally, while BTS lease contracts vary from project to project, many of these agreements generally include several common factors:
- The lease term is typically longer than a standard commercial lease, often lasting between 10 and 20 years.
- The tenant may have exclusive use of the property during the lease term.
- Ongoing maintenance and repair costs and property taxes are the tenant’s responsibility after occupancy.
BTS leases are a way for tenants to occupy specially-made properties without having to finance the construction themselves. If you’re an investor interested in entering into a BTS leasing agreement, working with an experienced commercial real estate attorney is recommended. A lawyer specializing in BTS leases can help ensure your rights and interests are protected throughout the process.