The browser version you are using is not recommended for this site.
Please consider upgrading to the latest version of your browser by clicking one of the following links.

Build to Suit Lease: What It Means in Real Estate Investing?

Build to Suit Lease

Property owners who have vacant or ready-to-update property may wish to offer a built-to-suit lease. This means the property owner agrees to lease arrangements in which the owner works with a developer to build a property based on the tenant’s needs. For investors considering a vacant property, a build-to-suit lease could be advantageous if a prospective value exists in the area for new business development.

What is a Build-to-Suit Lease?

A build-to-suit lease is a legal contract between a tenant and a property owner in which the property owner or landlord agrees to build or modify a structure to meet the specific needs of the prospective tenant. The lease typically will be in place for a set number of years.

Critical to note is that the landlord does not typically have to pay for the cost of the property construction upfront. Instead, the landlord works with a developer who will construct the property and then recoup the investment by leasing the property to the landlord once the project is completed.

The key to this type of arrangement is that the tenant can obtain the specific type of customized building they need to run their commercial establishment without having to pay to build out the property themselves. The project developer will typically provide the raw land for the project, then design the space to meet the tenant’s needs, and finally construct the property according to those arrangements.

Make lenders compete for your business

Answer a few questions and get custom mortgage quotes. We'll match you with offers from our network of 650+ lenders.

How Does Build to Suit Lease Work in CRE Investment?

In commercial real estate investment, a build-to-suit lease works in a fairly straightforward manner:

  • The property developer and landlord agree to work together
  • Their objective is to create a custom-built property for a tenant
  • The tenant occupies the property for the length of the lease agreed upon in advance and does not have to pay outright for the construction of the building.

Here is an example of how the project may work. A developer owns a vacant plot of land in a busy city center. The developer agrees to work with a commercial company that needs specialized office space. The development company will build the property to meet the tenant’s expectations and lease the property to that tenant.

Types of Build-to-Suit Lease

There are various methods by which a build-to-suit lease can be created to meet the unique needs of the property owner, developer, and tenants. Commercial real estate investors can choose from these leases to determine the best structure for their financial needs.

Sale-Leaseback Agreement

For real estate investors, the sale-leaseback agreement is a common type involving the property owner and the lessee. In this situation, the property owner sells the property to the lessee. Then, the property owner leases it back from the lessee within the pre-arranged terms. In this situation, the purchase price of the new structure on the property is likely to be lower than the current market value.

In this situation, the landlord is selling the property to the tenant. They expect that the tenant will lease the property back to them. This is a typical route for raising capital for various goals, such as restructuring debt or building working capital for the organization.

Developer Agreement

Developer leases are also relatively common. The property developer and a commercial entity are typically involved in this agreement. A broker facilitates most. The tenant works with a developer to find a property that fits their needs. The developer builds a property to meet the tenant’s expected needs for the type of business they plan to operate in that structure.

In this arrangement, the tenant enters into a legally binding agreement to lease the property from the developer for a specific time. Most often, this is for at least ten years, but it can be much longer. There are often opportunities to renew the lease longer. In some situations, the developer agreement may allow the tenant to purchase the property at the end of the lease term.

Reverse Build-to-Suit Agreement

This is one of the most common build-to-suit agreements in situations where the tenant serves as the property developer. The tenant is responsible for the construction of the property, with the approval of the landlord. The landlord funds the construction of the property on the provided land.

In this situation, the landlord is not obligated to pay for added costs, including the design and engineering fees. This type of lease arrangement works well when the tenant already owns real estate or has the means to develop the piece of real estate. This may be due to owning a general contracting company.

Note, too, that these lease agreement structures are just frameworks. Many have additional features or added clauses that can influence how the property is used and how the contract is maintained over a more extended period of time. Many will be long-term leases with long-term opportunities for both parties.

Benefits of Build-to-Suit Leases

All real estate transactions require due diligence, and a component of that is understanding the specific transaction’s pros and cons within current market conditions. Overall, there are several key benefits to a build-to-suit lease.

  • This method allows for the operation of a business on a new property without putting all of the necessary capital upfront to build that structure.
  • The tenant benefits from having a property custom-built to their needs. They do not have to retrofit the property in any other way.
  • Typically, tenants are given some insight into the layout and design applications, though the property owner will still have oversight.
  • The investor benefits because they do not have to find a tenant to meet the current configurations of the property.

Risks and Considerations of Build-to-Suit Lease

Numerous careful considerations must be considered before moving forward with a build-to-suit lease.

  • Tenants typically must enter into a long-term lease agreement. For tenants that are a new business or unproven organization, this can prove difficult to do over an extended period. Most of these leases are in place for at least ten years.
  • In situations where the tenant does plan to leave the property while the lease agreement is in place for that length of time, there could be a substantial fee to pay.
  • It is also difficult for the property owner to find a new tenant if the space was custom-built to meet the specific needs of that one particular tenant. The extensiveness of that customization will play a role in determining the value here.
  • Most often, tenants maintain responsibility for all maintenance, updates, and repairs to the property. This adds up over time.
  • Developers must also consider any potential cost overruns with these properties.

Wrapping Up

Critical in using a build-to-suit lease is structuring it to meet the specific needs of most involved. Typically, there are advantages in these leasing options, but only if both parties benefit from the arrangement. With long-term leases like these, it can be beneficial for all parties to complete due diligence before moving into these opportunities.

About Author

David Luke

David Luke

David was immediately drawn to the CommLoan mission of creating a better borrower experience when joining the firm in 2015. Initially, David helped grow the lenders on the platform by 6X and worked closely with the software team to improve accuracy and efficiency within the loan fulfillment process. David has underwritten and closed more than $2 billion in transactions ranging from bridge to permanent financing across all major capital sources. He appreciates the wealth creation that real estate has to offer and has been self-managing a small portfolio of single and multifamily properties for the last 10 years. David earned a master’s degree in business from W.P. Carey School of Business at ASU and will be completing his CCIM Designation in 2021. Show More...