Build to Suit – Is it for You?

Build-to-Suit for Commercial Real Estate

There is another approach to business space other than buying or leasing existing space.  For retail, office and most commercial enterprises, leasing is the chosen space acquisition method, but there are situations where leasing isn’t the best approach.  Let’s take a look at another approach that could be right for your business; built to suit.

What is build to suit?

A build to suit project is one in which the location, design and specifications of construction are all determined by one major occupant.  Though there may be more occupants once the space is constructed, everything about the building and its construction is specified by a single user.  An example might be a major user completing a build to suit project with additional space planned for leasing to future business tenants.

Why do build to suit?

A major motivator for a business to look into build to suit is a shortage of the type of space that is needed.  In some markets office space can be in very short supply, and what is available may be in undesirable areas.  Another reason to consider this approach is a specialized need or space requirement.  If something you do in your business requires a floor plan, facilities or equipment that cannot be accommodated by available space, build to suit may be the best way to go.  Perhaps your business is about to make a major long term commitment to a market area and it makes good financial sense to create the perfect business facility in a desirable location.  There are also tax considerations that can make build to suit a viable approach.

How is build to suit structured as a project?

There are three approaches to the build to suit project, and the one chosen is usually based on the experience and desired commitment of time and resources of the business seeking the space.

  1. The DIY approach:  This is the do-it-yourself developer method.  The business secures financing, acquires the land, hires the general contractor, and moves the project to completion.  Once completed, the business can simply continue ownership or can sell the property to an investor and lease it back.
  2. Hire a developer:  The user passes all responsibility for the project to a developer, construction as well as financing, and then leases the property for the business.  For more information see these articles about gross and net lease arrangements  and the structure of a triple net lease.
  3. Hybrid of the two:  This can be a joint venture with a developer, or an equity sharing arrangement resulting in some portion of ownership on completion.

There is a lot of flexibility in setting up a build to suit project, which can be the ultimate motivation to take this approach.

Advantages of build to suit:

There is no better way to acquire a business space that is totally designed and suited to your business operations.  It increases efficiency, lowers operating costs, and can enhance profitability.  Taking this approach can also help a business with their branding and image through design and layout.  Operating efficiency through new construction with the latest energy efficiency concepts will lower costs and increase profitability throughout the life of ownership.  Build to suit also allows the business to accommodate future expansion in the original construction.

Disadvantages of build to suit:

The first and a very important consideration is the long term nature of this decision.  There must be a long term commitment, which requires a careful assessment of the business, the market area, and any future expansion or business changes that may be required.  Unlike leasing an existing space, it can take years to move into a build to suit structure.  This is a more expensive approach than leasing existing space.  However, over the long haul it can recoup some of that extra expense through operational efficiency and the avoidance of future moves that may be forced upon the business by landlords.

Build to suit isn’t for every business.  However, if your research shows that the advantages outweigh the other issues, it can be a comfortable long term decision for your business.

 

The Commercial Space Tenant Improvement Allowance (TIA)

Though companies engaged in the same types of business have similar lease space needs, such as retail clothing sales or grocery stores, they are each unique in certain ways.  There are also commercial real estate needs that are very specialized, possibly requiring work stations, special equipment accommodations or built-in modifications to the lease space.

Generally, things that aren’t attached, such as free-standing shelving or equipment, are considered trade fixtures and not an improvement to the property.  Your landlord will generally leave these trade fixtures up to you and you’ll install them at your expense.  Changes or additions that are attached are generally considered leasehold improvements, and your landlord will want some control over what you do and how you do it.

Improvements remain after you’re gone, so naturally the landlord wants to know that they will not damage the value of the property or impair the ability to lease it out.  If you need to make improvements to the property to accommodate your business operations, your landlord will want to know what you need and to negotiate how the improvements will be done, by whom, and who is paying for them.

One approach is to just negotiate into the lease that the landlord will do the required work at their expense, a turnkey approach.  Of course the tenant has no control over costs, and the landlord will certainly cushion their lease amount to cover possible cost overruns.  Often the best approach is the TIA, Tenant Improvement Allowance.

The Tenant Improvement Allowance – What it Is – Pros and Cons

The TIA is a monetary allowance from the landlord to the tenant for improvements to accommodate the business in the space.  This can be allocated on a per-square-foot basis or a lump sum amount.  In some cases it can be a trade-off for free rent as well.

Pros of the Tenant Improvement Allowance

  • Gives some negotiated control to the tenant of the process, contractors used, and work to be performed.
  • The tenant has more incentive to control costs than the landlord in most cases.
  • Can provide the tenant with better control of the outcome and usability of the improvements.
  • Allows the tenant to select some or all materials and make quality decisions.

Cons of the Tenant Improvement Allowance

  • The tenant is normally responsible for any cost overruns exceeding the negotiated TIA amount.
  • The tenant may have less buying power than the landlord, raising costs for work and materials.
  • Liability and damage can fall to the tenant to remedy.
  • The tenant will spend more of their time in planning and execution, though the results can justify it.

The Tenant Improvement Allowance is a popular way to handle improvements necessary to adapt the lease space to the tenant’s business operations, but care should be taken in negotiating the details.

How Do I Use the Tenant Improvement Allowance and Who Does the Work?

There are several very important negotiated items in a Tenant Improvement Allowance.  The landlord will want some control over what is done to be sure that the property’s future value isn’t negatively impacted by your modifications.  An example might be cutting a new stairwell between floors, a major modification that can have code or future tenant desirability considerations.

The landlord will almost certainly want to approve the major changes to be done, but then may leave the work to you and your selected contractors.  There will also definitely be requirements for you to verify proper bonding, insurance and licensing of all work and contractors.  Sometimes the negotiated terms will split certain work between the contractor and the tenant, especially when major modifications require changes to the structure’s envelope, utilities or safety features.  When work is split between the tenant and landlord, extra care must be taken in negotiating the relative responsibility for costs or unexpected overruns due to structural issues not known ahead of time.

How Do I Get the Best Negotiated Deal on my Tenant Improvement Allowance?

First, keep in mind that landlords didn’t get where they are by being naive business people.  They have a pretty good handle on all of their costs and operating expenses, and you can rest assured that any money or considerations they allow you in a Tenant Improvement Allowance are all factored into the rent over the term of the lease.  It’s best to negotiate your TIA before any lease is signed, and some of the important points to consider include:

  • Is the landlord charging any overhead or administrative fees, even if you’re doing and paying for the work?
  • If you come in under budget, make sure you get to keep the balance of the TIA, which can be a trade-off for free rent.
  • Get broad discretion over what you can spend the TIA money for, such as architect, attorney, or consultant fees, as well as permit and inspection costs.
  • If cost overruns are due to unknown structural problems there before your tenancy, who is to pay for them?

There are other items, many varying considerably with the type of business and the space to be rented.

You Need Experienced Negotiating Help

Owners of commercial buildings, malls, strip centers and industrial properties are often assisted by a team of investment advisors, attorneys and others in the management of their business.  You will be in negotiations with this team, and they are very good at covering their interests and maximizing their return on investment.

Don’t go it alone.  Rodney McNabb with MainStreet Realty Services has been on the tenants’ side of these Tenant Improvement Allowance and lease negotiations.  Take advantage of his experience and skills in getting you the best deal possible.  It’s your future profits for the entire lease term, so get the best.

How to Market and Sublease Raleigh Commercial Real Estate

Unfortunately, circumstances arise when a company no longer has use for commercial space it has leased. Needs may have changed regarding the size of the business or location, or a company may have experienced financial reversals and must rid itself of the unnecessary expense. Whatever the cause, unwanted commercial space is expensive. Companies holding such leases are hemorrhaging money every month and want relief fast.

“The larger the square footage and longer the lease term, the greater the exposure,” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “Maximizing time and efficiency is vital to properly sublease space and mitigate losses.”

Smart Business spoke to Chavez about the few important steps companies should consider before taking their space to market.

What should tenants consider first when looking to sublease space?

First, read the sublease and default sections of your lease and be aware of any sublease restrictions that may exist. Landlords’ ‘form’ leases often prohibit subleasing to existing tenants in their building, or to companies with whom the landlord is engaged in active negotiations. Likewise, governmental organizations with high traffic count, or the Internal Revenue Service, for example, may be excluded because the landlord deems them an unfit occupant of their building. It would be most unfortunate to spend time and money negotiating and documenting a sublease only to find out in the 11th hour that the proposed subtenant is prohibited.

How can they improve the chances that the space will be sublet?

Have a solid marketing plan. Interview real estate brokers that are active in your market. Understand exactly what measures they will employ to sublease your space and keep you informed. Know their track record and ask for references. Make 1certain that any listing agreements they may have in the area are not actually conflicting interests. Such brokers may be more beholding to their landlord clients, as they are simply the bigger fish. Ask if the broker can show you a ‘sublease recovery analysis.’ If they do not understand this concept, it may be wise to move on.

It is imperative to understand the subtleties in your market and price the space properly. Pricing the space too high will likely cause the space to sit vacant and allow the financial hemorrhage to continue. Price too low and money is left on the table unnecessarily. The balance between price and timing must be carefully addressed early and clearly. Discuss commission incentives and see if they are commonplace in the market and likely to bring better results.

Also, be certain that your broker has the ability to find tenants that are actively seeking space in the market. All too often sublease space is listed on a marketing service website and brokers wait for the phone to ring. The likelihood of success is enhanced if your broker has an active and well-conceived marketing strategy. Subleasing space properly is more work, so be sure to agree upon a reporting process and keep your brokers accountable for weekly activity reports.

What other challenges must be overcome?

Unless the real estate market is ‘white-hot,’ subleasing space is difficult. Unlike the building owner, a tenant (or sublandlord) only has its specific amount of space, design and floor plan available. Sublandlords are seldom in a position to spend vast sums of money retrofitting their space to suite another occupant. Accordingly, the target audience for subleases is dramatically reduced as compared to what a landlord can offer. Pricing the sublease space below the landlord’s rates is often the only viable way to quickly sublease the space. Timing is extremely critical. It does a company little good if their space works nicely for a particular company but they cannot occupy for 18 months because that is when their lease expires. This would cost a company with 10,000 square feet nearly a half-million dollars in rent just waiting for the subtenant to become viable.

What are the final steps once a subtenant has been identified?

It is important to qualify the company before agreeing to final terms. Be certain to review financial statements and research the company as well as their industry. You want to be as certain as possible that the subtenant will continue to pay their sublease rent. The last thing a sublandlord needs is to spend even more time and money evicting a deadbeat subtenant, and then have to start the process all over again.

Inform your landlord in writing once you decided to sublease space. This may expedite the landlord’s consent process, which will be required to consummate the sublease. Additionally, you may get lucky and the landlord could elect to ‘recapture’ the space if they have another party interested.

In rare instances, a sublandlord may be able to profit from subleasing space due to an upward trend in market conditions. This is more typical in a retail setting, but can happen in office or industrial sectors as well. Once again, look to your lease before celebrating. The landlord may be entitled to all profits if the lease was poorly negotiated. If that is the case, the tenant might as well sublease the space at its below-market rate and a find subtenant much sooner. Again, read your lease, as you may not be permitted to undercut the landlord’s rates. Most commercial leases are ultimately drafted such that the landlord and tenant share any sublease profits on a 50/50 basis, after the tenant has recovered reasonable fees for commissions, improvement allowances and other marketing expenses.

As you can see, subleasing space is no fun. There is little certainty with regard to the outcome and very limited flexibility. The best defense is to plan ahead and exercise extreme caution when entering into a lease in the first place.