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.

 

Five Steps to a Successful Commercial Property Selection

Of course, commercial property selection is a broad topic due to the varied nature of “commercial” properties.  However, the majority of investors are considering retail space or office space for investment.  Let’s look at an overview of five factors that apply to both retail and office space commercial property selection for long term ROI.

#1 Your Investment Goals

Of course, Return On Investment is always the primary goal.  However, there are other considerations before a substantial investment involving commercial property selection.  Are you seeking a passive role, active management participation, or something in between?  Commercial properties require a great deal more management and sales/marketing activity.  If you do not wish to be involved, you’ll take a different approach to commercial property selection and your role.

Perhaps you’ll join others in a partnership, with some partners only involved monetarily and others also taking a management and marketing role.  If you want to be hands-on, your commercial property selection could be a smaller office complex that will not require as much of your time.  Before setting out to research properties, have your target price range, investment objectives, and involvement level figured out.

#2 The Local Economy – Business and Consumer

This is an interesting factor in commercial property selection because you may not want to rely solely on your business clients’ economic research and outlook.  Suppose they’re haphazard about tracking their customer base and demand.  Or maybe they’re not very diligent in other areas of market research that could create stress in their business in the near future.

You want to do two levels of research, business and consumer.  Let’s use a small retail strip center as an example.  It’s been a good investment for the current owner, but they’re retiring and want to leave the area.  It has five units, currently a nail salon, barber shop, small organic grocery, to-go barbecue place, and a payday loan business.  They have been fairly stable tenants and rents are mostly at market rates.

However, what’s going on in the local economy?  They’re in place and likely just struggling to maintain sales, not necessarily checking the economy to see if leaving is the right alternative.  Either way, you lose a tenant to bankruptcy or they move to go where the customers are.  Your job in commercial property selection in this case is to not only check their current business health, but also the consumers in the area.  Are they moving away, or is the area growing?  Are major employers relocating?  Will the current demand for these services remain viable for your ownership period?  Are wages dropping such that nail salons and gourmet organic products will be priced out of range for the new consumers?

#3 Physical Location

This is really important, as traffic for retail is crucial, and even office complexes must be relatively easy to access and not too far out of the areas where the customers live.  Just travel the old Route 66 to see what happens to businesses when a new freeway moves the traffic away.  It’s usually not that dramatic, but our example retail strip center could be in big trouble if the previously busy street is modified such that it’s harder to access.  Or perhaps a nearby parallel street is widened so traffic moves to the faster route.

#4 Age & Condition

This is more than just how old the building is and if it is in need of work.  That grocery store could have a walk-in cooler and other equipment that’s reached the end of its useful life.  Keeping it repaired or buying new are both expensive projects to be considered.  How about the roof, heating and cooling, and parking lot conditions?  Even if acceptable condition-wise, a lower offering price may be the best approach.  Are there conditions that may be the target of code enforcement, such as handicap access, etc. that could be expensive to remedy?

#5 Are the Numbers Real Numbers?

You’re going to be checking out leases very carefully.  Sometimes landlords allow tenants to work off lease payments, and the cash flow isn’t really as the lease sets out.  Don’t just check the leases, check the deposits against them.  Are some of the units under-leased or the opposite?  Sometimes a poor negotiator as a tenant will overpay for their space, but when they figure it out they leave and the next one isn’t so gullible.

These are broad considerations, but if you take these steps in Raleigh area commercial property selection you’ll probably be happy with the result for years to come.

The Classification of Raleigh Office Space

Raleigh Office Space is typically classified into two different categories:

New Construction:  Space that has never been occupied, regardless of when it was built; and

Second-Generation Space:  Space that has been occupied by a tenant, regardless of how many prior occupants there have been.

NEW CONSTRUCTION

Office space within a newly constructed building is typically not finished.  The owner purposely leaves everything unfinished, knowing that tenants will want things to match their own specifications.  Instead of finishing the space, the owner budgets money to finish each space.  This is typically done in one of two ways:

1) The first way is that owners often budget amounts of installed tenant improvement materials to create the finished office space.  These materials are specified in what is known as a Tenant Improvement Work Letter.

The Tenant Improvement Work Order

New, unfinished space is provided with a list of materials that the owner will pay to have installed.  These materials usually include a number of components such as:

  • Doors
  • Specific amounts of drywall partitions
  • A ceiling system
  • Lighting
  • HVAC distribution components (ducting, boxes, and registers)
  • Electrical outlets
  • Boxes and conduit for communications wiring
  • Paint, carpet or other floor covering, baseboard molding

How much of this material is offered to the tenant is based on the number of square feet leased; for example, “one door for each 300 square feet, one electrical outlet per 125 square feet”, and so on.  The Tenant Improvement Work Letter is often subject to much negotiation.  Buildings offering a Tenant Improvement Work Letter should be able to produce a list of improvement items they’re offering in clearly defined amounts.

2) The second way that new construction often budgets for tenant improvements is to offer an allowance.  The dollar amount of the allowance is based upon the number of square feet being leased and is called the ‘Tenant Improvement Allowance’ or ‘TI Allowance.”

Example:  The TI Allowance could be stated as:  $25 per square foot.  Of course, the range of the TI allowance can be quite broad depending on building costs in your area, how competitive the market is, the intended image of the building and more.

When a new tenant’s needs exceed the budgeted amounts, then the overage needs to be negotiated between the parties.  the budgeted amount is referred to as the “building standard amount and quality”.  Tenants can exceed the building standard in both the quantity and the quality of the improvements and this is referred to as the “over standard tenant improvements.”

Over-Standard Improvement Examples

  • Interior glass partitions
  • Fabric wall coverings
  • Custom lighting
  • Custom cabinetry
  • Kitchens or plumbed break rooms
  • Executive washrooms or showers
  • Built-in projection or audiovisual equipment
  • Space-saver file systems
  • Supplemental cooling
  • Computer rooms

SECOND GENERATION SPACE

If the property isn’t ‘new construction’ then it is ‘second generation space.’  All previously occupied space is second-generation space.

Generally speaking, owners do not budget money in advance for remodeling space that has already been occupied.  But in softer markets, or as an incentive for high-quality tenants, they are likely to pay for some tenant improvements.

A Word of Caution

When dealing with second-generation space, it is also important to know about building and fire code compliance issues and other deficiencies in the existing space that might need to be corrected if a permit for construction is required.  You may be tempted to believe that only a few walls and doors need to be added to make the space suitable for your needs.  However, since all construction requires a building permit, any changes to a space could trigger a number of compliance issues.  It is best to ask what code compliance issues are known to the owners or their representatives, so there are no surprises when it comes to tenant improvement costs.  It is not uncommon to find that  the owners have budgeted money for tenant improvements because they already know that compliance issues exist.  Many times, what they have budgeted barely covers enough to bring the space up to code and leaves nothing for additional improvements.

The same is true for deficiencies in meeting the requirements for the Americans with Disability Act (ADA).  You can usually expect that, unless recently renovated, older properties will be required to make some compliance and ADA upgrades when applying for a building permit.

Questions

  • What is being offered for tenant improvements?
  • How does the tenant want and need the space to look and feel?
  • Can the tenant’s needs be met by what is being offered?  If not, what will it cost to build out the space to meet the tenant’s needs?

Parking as it Relates to Raleigh Office Space

Parking is another important aspect of Raleigh office space that will affect how suitable the property is for certain tenants.

The number of parking spaces bears a relationship to the number of square feet of space in the project.  This is known as the parking ratio and is often expressed as the number of spaces available per thousand or thousands of square feet.  Some urban office towers can offer 1 to 2 spaces per thousand square feet.  Because core urban areas provide for and rely upon public transportation systems, it is not uncommon for urban office buildings to have very little or no parking for the building.  While developers see the importance of having a parking garage, the permitting government authority will often sharply limit the amount of parking they will allow the developer to construct.  They do this in the hopes of fostering the use of public transportation and reducing traffic congestion.  There may also be practical limits as to how much underground parking can physically be created in a very tall building.  If you are looking at a building with 15,000 sf per floor and only on parking space per floor available, the ration would be 1 per 15,000.  Certainly a ration this low is not common except in high-rise offices in high-density urban areas.

As you move out of the downtown areas, parking ratios increase to 4 and 5 per thousand square feet in suburban office parks because there is a greater expectation that people will drive to work.  The amount of parking available will often dictate the types of tenants that can be located in the building.  For instance, some businesses that use office space, but have a little bit of retail component to them, such as doctors, tax preparers, financial planners, etc., may not be able to lease space in certain buildings if the parking ratio is too low to accommodate clients.

Parking can also have an affect on the common area maintenance charges.

Parking Can Be Expensive

Exterior parking lots and garages are common areas that need to be maintained.  Unless the parking is paid parking, the expenses for maintenance are part of the common area maintenance charges.  Expensive parking areas need security, cleaning, lighting, irrigation, and landscaping.  This is an important comparison when analyzing urban office buildings versus suburban office spaces.  In suburban office parks, the rent charged may be increased by the addition of common-area maintenance charges.  It is important to compare apples-to-apples.  In other words, get all of the expenses for each property before you compare them.  A lower rent in one building may not be so low once you factor in the load factors and the common area maintenance charges.

Questions

  • How much parking is available?
  • What is the parking ratio?
  • What forms of public transportation is available nearby?

Electricity, Communications & Other Cabling Needs in Raleigh Office Space

Electrical capacity is very important.  Tenants want to know how many watts per square foot are available.  (While electricity needs in Raleigh Office Space is rising, it’s pretty typical to see four watts per square foot available).

It is also important to know how the electricity is being distributed, and what the possibilities and costs are if it needs to be distributed differently.

Power Distribution

You need not be an electrician, but knowing a little about how power is distributed can be critical to your success.  Private office environments allow for power and communication lines to be distributed through the ceiling plenum and down the walls.  A ceiling plenum is the area above a dropped ceiling and the bottom of the floor above.

Some buildings have under-floor duct or trench systems which allow all the power and communication cabling to be pulled to almost any area of the floor, saving substantially on the cost of electrical distribution when compared to floors that must have holes drilled into the space below and have the cabling pulled through from the ceiling phenum below.  These holes are referred to as core drillings and can be done in most types of construction, albeit expensively.

There is one type of construction, known as post tension construction, in which core drilling is very limited, if not impossible.  The location for any core drills must be x-rayed before being drilled and a very limited number of holes are permitted.  The reason has to do with high-tension (stressed) elements in the floor that cannot be touched lest the integrity of the structure be compromised.  be sure to ask the building owner whether or not core drilling is feasible or permitted, before performing such work.

A Note of Caution

Each time a permit is pulled to do any construction work, such as when a tenant is building out their space, there may need to be improvements made to bring the space up to the latest codes.  This often affects power and lighting.  Many spaces that have been occupied for many years haven’t been updated to be compliant with the latest safety or energy efficient laws.  Make sure that when you are analyzing space you know how long it’s been since a permit was last pulled and you know if there are any code compliance issues that will be triggered by applying for a building permit.

Communication Wiring

Communication wiring can be distributed in the same manner as electrical wiring and each building has certain capabilities based on what services that have been brought to the building.

If the capabilities of the building match the tenant’s needs, there’s still one more thing to consider.  Services in the building may not have been brought to the tenant’s space.  To do so requires wiring and cabling to be pulled to the space and distributed as needed.  Landlords don’t want to be involved in the installation of the tenant’s communications wiring and expect that in most cases it will be the tenant who pays for it.  Because communication lines, voice and data lines, plus high speed internet access are very important, the location of fiber optic cables is a determining factor for some companies in relocation.  However, the building’s responsibility usually ends at bringing these services to the building.  The tenant’s responsibility is in distributing throughout the premises.  When dealing with either new construction or properties that have undergone such extensive renovations that old electrical and communication cabling has to be removed, be sure that the property owner is willing to bring the utilities and data lines to the premises or at least to the electrical and communication closets on the floor, otherwise you might find there is a gap between what the owner is willing to deliver and what the tenant expects to receive.  A 40th floor tenant that has to bring voice and data cabling from the basement at their own expense might become very irritated if they thought the tie-in was just down the hall.

Some Questions to Ask

  • What communication services are available in the building?
  • Telephone?  Satellite?  High-Speed Internet?   Cable?
  • Are all of these services available in this space?
  • If not, how far away are they?

Heating, Ventilation & Air Conditioning (HVAC) with Raleigh Office Space

Another big question to ask potential landlords about Raleigh Office Space for Lease has to do with air temperature and air quality in a building.  While many older office buildings offer only central heating and operable windows for ventilating, modern office buildings are mechanically heated, ventilated and air conditioned.  The system used for this is called the HVAC system or Heating Ventilation & Air Conditioning system.

While one does not need to be an HVAC expert, one should understand the basic terms and know the right questions to ask.

One important set of questions has to do with hours of operation.

Hours of Operation

Office buildings offer the heating, ventilating and air conditioning services during specific hours.  If a tenant does work at time other than the building operational hours, they will have to pay for the HVAC to be run during those hours.  The problem is that many buildings built prior to the energy crunch of the mid-1970;s have one or two central building chillers for the HVAC function.  Buildings with only a few chillers charge higher rates for after-hours HVAC services because, in effect, they are turning on the HVAC for the whole building, or at least a significant portion of the building.  In addition, some buildings require that additional personnel be on site to operate the HVAC.  This obviously costs more money.  Even in more modern buildings, where HVAC can be turned on by the tenants for only their space, it is still typically an extra cost.  So it is important for tenants to know the hours that they will need to occupy their space and it is important to know the costs of extended hours HVAC operation.

Another important consideration has to do with the amount of recycled air versus fresh outside air per cycle of the system.  Once again, you do not need to be an air conditioning expert, but you do need to ask the right questions.

Sick Buildings

To save energy, many building systems re-circulate air that has already been heated or cooled and mix that with a percentage of fresh outside air.  This is important to know because some major corporations, as a corporate policy, refuse to occupy a building that cannot provide 100% fresh air per cycle.  They are trying to avoid the attendant liabilities of airborne maladies that can be transmitted throughout the building, and lead to what is referred to as ‘sick building syndrome.’

Questions

Some of the most important questions to ask about HVAC systems include:

  • How is the building heated, cooled and ventilated?
  • What are the standard hours of operation for the HVAC system?
  • What does it cost to run the HVAC system after hours?
  • How much fresh air brought in on every cycle?

The Importance of Life Safety with Raleigh Office Space

Life Safety is an aspect of Raleigh Office Space that is in a state of nearly constant change.  Laws are frequently added, updated and amended.  The goal is to make sure that buildings are safe for those occupying them and most of the laws do a good job for ensuring a level of safety.  Unfortunately, they add a level of complexity to what you do.  At a bare minimum, you need to know what some of today’s basic requirements are and know enough to ask about a building’s compliance with those basic requirements.

Some things to look for, include:

Exits and Stairs:  One basic requirement in almost every area is there must be multiple ways to get off a floor without using the elevators in emergency situations.  In most areas, this no longer includes external fire escapes.  In addition, the stairs must be a sufficient distance apart to provide adequate access for all of the occupants of the floor.  It is easy to assume that all buildings have two stairwells, but the truth is that many older buildings and buildings that are industrial conversions to office space may be not be compliant.  This could be because the building was vacant for a while or the same tenant occupied it for many years.  But when a permit is pulled for improvements, code compliance issues arrive.

Fire Technology:  Another life safety category to be aware of includes all of the technological responses to fire.  The building must obviously have working fire alarms, but these days, strobe lights are used to augment sound-emitting fire alarms to ensure that the hearing impaired are included in the alarms.  In many older buildings that isolate the elevator lobbies are also usually required in the event of fire.  If you step off an elevator and there is no smoke vestibule with doors that automatically close when the alarms go off, then you know there’s probably a problem that needs to be updated.  Sprinklers are also generally a requirement in modern office construction and sprinkler retrofits can be required when remodeling a tenant’s space.  Often, sprinkler heads need to be changed to a more modern type when space is remodeled.  You don’t need to be the world’s leading expert in sprinkler heads and fire safety, but you do need to know enough to ask the questions.  Find out what the fire codes are in your area and ask building owners if everything is up to date.

Signs:  Proper life safety postings and signage are generally required.  Exit signs, escape route maps, and maximum occupancy signs are examples of some of the things that are requirements in most Raleigh commercial real estate.  These are relatively small things compared to some of the other life safety requirements, but important nonetheless.  Their absence can be a sign that there are other compliance issues.

American’s With Disabilities Act (ADA) Compliance:  In the United States, another aspect of life safety involves the things necessary for compliance with the Americans With Disabilities Act, or ADA.  There are people in your community who are experts and can help you with ADA compliance.  Generally speaking, wheelchair access to buildings with either ramps or lifts is required.  Doors, hallways, and other spaces need to be wide enough to allow for wheel chairs.  Bathrooms need wheelchair access and the appropriate grab-bars and lower sinks.  Braille signs need to be present, and more.

Questions

Some important questions to ask include:

  • Are you fully compliant with the latest fire and ADA codes? 
  • What kind of sprinklers and other emergency apparatus are present?
  • How long were the previous occupants here?
  • When was the last time a building permit was pulled for this space?

The importance of Analyzing Elevators in Raleigh Office Spaces

It is very important to know the elevator capacity in an office building because it will help you to determine the best tenants for the building.  This includes passenger elevators as well as freight elevators.

In modern, recently constructed buildings, elevator capacity is engineered for the amount of space in the building.  But older buildings may or may not be as well served by their elevator systems.  Likewise, many revitalized, older downtowns have buildings that were industrial buildings in an earlier life, but have been modernized or converted into office space.  These converted industrial buildings may be substantially under-served with older, converted and slower elevators.

Some tenants arrive at their office early and then don’t leave until the end of the day, so they don’t need as much elevator efficiency.  Others are in and out all day, so elevator efficiency and speed are important considerations.  Some tenants have clients visit and want a more upscale presentation, while others don’t mind having older-looking elevators. Other tenants frequently use freight elevators and may even need them to go right to loading docks.

Investments can also be impacted by costs associated with maintaining or modernizing the elevators, so it is very important to analyze the elevators in an office building that you are considering purchasing.

Common Areas & Load Factor in Raleigh Office Spaces?

All multi-story, Raleigh Office Space have core/common areas.  (The terms ‘core areas’ and ‘common areas’ are typically used interchangeably.

A common area, in Raleigh office space, is that area of the building that is allocated to provide services to all the tenants in the building.  For instance, common areas give us access to the upper floors via elevator shafts and stairwells, and provide other shafts for services such as ventilation, electrical and communication.

The common areas include hallways that allow for circulation in and around the floors of the building, the rest rooms, and any service areas such as electrical , mechanical and communications closets.  Generally speaking, the parts of the building that are there to benefit all the tenants are termed the common areas, because they are used in common with all the tenants.  They also provide for safety features of the building.

The most customary components of common areas include:

  • The main lobby and entry
  • the elevators and tenant lobbies
  • the fire and general circulation corridors or hallways
  • the stairs, stairwells and service shafts
  • the public restrooms
  • the mechanical, electrical and communication rooms
  • the janitorial closets
  • the fire command and pump room
  • the freight elevator(s) and/or loading docks
  • any vending machine areas
  • mail rooms accessed by all tenants
  • any other exiting corridors.

The core area of a building can be at the center of the building, slightly offset from the center of the building, or along one side of the building.  Buildings are referred to as ‘center-core’, ‘offset-center core’ or ‘side-core’ buildings.

The location of common areas can impact tenants in two very important ways:

  1. efficiency of their space; and
  2. load factors

Center-core buildings tend to be more efficient for office layouts needing a high percentage of window-line offices.  In a center core building, you often see private offices around the perimeter, with some support staff workstations between the perimeter offices and the core area.  An example tenant for this would be a law firm.

Side core buildings are well suited to large, open floor plans utilizing panelized furniture systems.  Example tenants for this would be a large telemarketer, software developer or sales force.

A “load factor” is the difference between what are known as the ‘usable’ and the ‘rentable’ square footage.  Generally speaking, the space inside a tenant’s suite is called the ‘usable’ square footage.  However, since the tenant desires some benefit from the space in the common areas, the owner needs to be compensated for all of the space in the building, including the space dedicated to the common areas.  Therefore, tenant’s don’t pay rent based on just the usable square footage within their suite.  Instead, each office space is allocated a percentage of the common areas and the combined calculation is known as the ‘rentable’ square footage.  The tenant pays rent on the rentable square footage.  The difference between useable and rentable square footage is known as the load factor.

Load factors can vary greatly.  Some buildings have very expansive common areas and therefore load factors are high.  Other buildings have minimal core areas, so the load factors are relatively low.  Typically, the larger the floor plan, the lower the load factor because there’s more square footage available that can be occupied by tenants in proportion to common areas.

How to Calculate Load Factors

There is a simple formula for calculating load factors.  You deduct the usable square footage from the rentable square footage and divide the result by the usable square footage.  For example:

  • 10,000 rentable square feet minus 8,800 usable square feet equals 1,200 square feet of common area.
  • 1,200 square feet of common area divide by 8,800 equals a 13.63% load factor.

You can verify this by placing the whole number 1 in front of 13.63% and multiplying the 8,800 usable square feet by 1.1363 arriving at 10,000 rentable square feet.

What are Common Area Maintenance Charges (CAM’s) with Office Spaces?

A lot of Raleigh Office Space has exterior common areas.  These areas are the parking lots, sidewalks and landscaped areas that need to be cleaned, maintained, secured, lighted and irrigated.  There are expenses in maintaining these common areas that are divided up and billed to the tenants in the building.  It is very important when analyzing an office building that you include both the load factors and the common area maintenance charges in your analysis.