Build-to-Suit Leases: Pros and Cons of BTS Leases

A build-to-suit lease (BTS) is a type of commercial real estate agreement in which a business commissions a real estate developer to build a commercial property without putting forth any capital. In this arrangement, the real estate developer designs, permits, finances, and builds the new building based on the business's specifications. The developer then leases the property back to the company when construction is complete. The developer covers all construction costs with the plan of making back the money through a long-term lease agreement, where they will serve as lessor and the business as lessee.

A build-to-suit lease agreement allows a business to customize the construction of a new commercial space without tying up potential working capital in real estate. Here’s how the process works:

• The partnership begins: First, the business enters into a contract with a building developer to construct a new building for its needs. The property developer covers the construction costs in exchange for a long-term stream of income through lease payments from the business that sought their help.
• Design and build: The developer designs and builds the commercial development, financing the entire construction and build-out of the property.
• Tenant moves in: After the developer completes the build, they become the landlord of the building, and the tenant pays rent to occupy the space for an agreed-upon lease term.
• Leasing to other tenants: Once the initial lease arrangement ends with the original business/tenant, the landlord/developer can lease the property to other commercial businesses.

There are three main types of build-to-suit developments:

1. 1. Developer agreement: A BTS lease with a developer agreement involves a business working with a commercial real estate broker to find a developer who can finance and build the property that they want. The chosen developer finances the land acquisition and construction costs. The business agrees to fulfill the lease for the duration of the construction period and as a tenant.
2. 2. Reverse build-to-suit: In a reverse build-to-suit agreement, the lessee or business designs and builds the building and hires the developer to finance the construction. This agreement is popular with large chain businesses that have built many of the same kinds of property. However, they can still lease the property rather than invest the capital in ownership.
3. 3. Sale-leaseback agreement: In this agreement, the business finances the land acquisition and the build. Sale-leaseback agreements hold the business responsible for hiring the general contractor. When the building is complete, the business finds an investor to buy the property, who will agree to lease it back to them after the purchase.
   

Here are some of the advantages of a build-to-suit lease for both the lesser and the lessee:

1. 1. Assured tenancy: For the developer, a build-to-suit agreement ensures that the property they’re investing in will have immediate, long-term tenancy upon completion. Many of these leases are also triple-net leases (NNN), which require businesses to cover maintenance costs and property taxes, meaning that the developer only needs to finance their mortgage costs (if they have any at all).
2. 2. Customization: The most significant advantage of the built-to-suit lease agreement for the business is that the development project is built to meet its specifications. This eliminates the need to develop and finance costly renovations that they might have needed for an existing space. Tenants can even negotiate the rental rate when the tenancy begins.
3. 3. Reduced capital investment: Small businesses don’t need to put up any money in a built-to-lease agreement because the property developer is responsible for all construction costs. This frees up any extra capital that the business has to invest back into itself. However, the business must cover lease payments on the property as the building is under construction.
4. 4. Tax benefits: A business’s rent payments under a build-to-suit lease are tax-deductible. If the business owns the commercial building, only the interest on their mortgage would be tax-deductible.

There are some drawbacks for both landlord and tenant when agreeing to a build-to-suit project, including:

1. 1. Construction costs: Financing a build-to-suit arrangement can be costly for the developer. They will only receive lease payments once the project is complete, meaning that they may be at a financial loss for a while.
2. 2. Credit requirements: Tenants must have strong credit to show developers that they can pay their rent for the length of the construction project up until the move-in date.
3. 3. Occupancy: If the lessee decides not to renew once the initial lease term ends, the developer is left with an untenanted property. Developers construct these custom buildings to the unique specifications of the initial tenant, making it difficult to find new commercial tenants to fill the property.
4. 4. Time: Build-to-suit properties may take a long time to complete, like any other major construction project. The months (or years) that a developer may take to build the structure can mean the business will have to operate without a location.

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