What is a Build to Lease Agreement?
Build to Lease is a type of real estate development in which a developer builds a building and then leases it to a third party. The lease can be for a short or long period of time, but generally , the purpose is a long term lease. Some municipalities have pre-ordained zoning that requires commercial and industrial buildings to be built and then leased (rather than sold), so there is a purpose behind the Build to Lease concept. Other developers like it because it reduces the carrying costs associated with the development of the building.
Key Elements in Build to Lease Agreements
While a build to lease agreement is essentially a modification of the standard construction contract, it has its own distinct set of features and requirements that parties should be aware of before entering into an agreement. To help parties better understand what provisions get included in a build to lease arrangement, it’s essential to identify the key components of these agreements which include: (i) terms of lease, (ii) responsibilities of each party, (iii) design specifications, (iv) methods of compensation, (v) construction timelines, and (vi) options for additional leasing periods.
Terms of Lease
The first component of a build to lease agreement is identifying the terms of a lease. More specifically, parties need to address the duration of the lease within the agreement. Other dilemmas parties should discuss early on to inform the lease term are whether the lease will be subsidized by a grant or loan, whether it will have preemptive renewal terms, and whether it will be designed as a lease-purchase agreement.
Responsibilities of Each Party
Identifying the responsibilities of each party to a build to lease agreement is essential to holding parties accountable to their contractual obligations. In this vein, the agreement should identify the target market of the project, describe how the developers will be compensated, and what their respective recordkeeping obligations are. Parties to a build to lease agreement should also address their responsibilities for any delays, how costs change over time, what rights the parties have to terminate the project before construction is complete, and how they will handle disputes between them.
Advantages of Build to Lease Deals for Developers and Occupants
The benefit of a build to lease agreement for the developer is that they are able to receive income from the tenant for a period of time under the lease and therefore do not carry vacant land risk as well as being able to sell a completed building. For the tenant, build to lease agreements are attractive because they are able to avoid the approval process in Council and can negotiate a surrender of the land at the end of the lease period so in some instances do not carry the risk of having to find another property if the lease is not renewed or extended. Some tenants are also attracted to the build to lease model because they have the opportunity to occupy a property custom designed to suit their needs from the outset and from a cash flow perspective are able to avoid a large expenditure at the outset to construct a building to suit.
Legal Aspects Surrounding Build to Lease Agreements
The legal landscape for build to lease agreements is fraught with potential pitfalls. One of the key areas of concern is zoning – the project must comply with local zoning ordinances, which may impose height restrictions, density limits, or use limitations on the leased land. If the land is not zoned for the intended use, the project may face delays or even be prohibited altogether. Moreover, obtaining the necessary zoning permits and approvals can be a time-consuming and expensive process.
Another important legal consideration is environmental regulation. Build to lease projects may require environmental impact assessments and reviews to ensure that they comply with state and federal law. These laws may include the National Environmental Policy Act (NEPA) and the Endangered Species Act (ESA). If the project fails to comply with these regulations, it could face significant delays or even be halted.
In addition to these concerns, build to lease agreements must also address issues related to construction contracts, financing, and property taxes. For example, the agreement should clearly spell out construction timelines and penalties for delays. Financing arrangements must be carefully structured to ensure that the developer has the necessary funds to complete the project. And property tax implications must be taken into account, as build to lease agreements can sometimes result in higher property taxes for the tenant.
Dispute resolution is another important legal consideration in build to lease agreements. Disputes may arise over construction defects, failure to make required improvements, or zoning compliance. It is essential to include clear dispute resolution provisions in the agreement, such as mediation or arbitration, to ensure that any disputes can be resolved efficiently and effectively.
Overall, build to lease agreements offer both risks and rewards for developers, landlords, and tenants. By carefully addressing the legal issues that may arise and including appropriate remedies for disputes, these agreements can benefit all parties.
Navigating the Negotiation Process for a Build to Lease Agreement
Effective negotiation of a Build to Lease Agreement can maximize benefits and minimize the risks to Lessees and Lessor. The breakdown of the process of negotiation is as follows:
Stage 1 – Lessor stage
This marks the beginning of the discussion process. Lessee should always take the chance to ask for any incentives that it can get. This stage requires negotiation on aspects such as rental, duration and specifications.
Stage 2 – Lessor Do’s: Money is power. The Lessor is under financial pressure to sell the property and is likely to prefer flexibility on the lease aspects rather than a sale. A couple of tips here are:
a) Consider renting to the Lessee on a short-term with an option to renew for further terms with a discount on the renewal such as a lower rental. The overall benefit is the Lessee will have the peace of mind during negotiations.
b) Even if the Lessee is seeking a purchase, it may very well need the property immediately. Offer the Lessee an opportunity to fulfil its immediate needs by renting the property.
Stage 3 – Lessor Don’ts:
a) Don’t agree to use its typical lease .
b) Do not allow the Lessee to think that the Lessor is desperate to rent or sell its property.
Stage 4 – Lessee stage:
Whole new set of dynamics in terms of pressure on the Lessee. The Lessee is likely to want to secure its position as early as possible. If the Lessor and Lessee are both keen to do business together, this should be the easiest stage of negotiation.
Stage 5 – Lessee Do’s:
a) Do increase the rental price. It is a very basic contract law principle that the rental is determined by what the market can bear. The Lessee should be fully interrogating this price till a point where the Lessee is satisfied it has done its job.
b) If there are significant improvements or upgrades to be made to the property the Lessee should seek to build a buffer in its favour by having the rental price to increase to cover the costs.
c) It’s all about flexibility for the Lessee so try to delay the signing of the lease for as long as possible without the deal falling through and for as short a period as possible thereafter.
Stage 6 – Lessee Don’ts
a) Don’t allow yourself to be rushed.
b) Don’t sign anything you aren’t 100% comfortable with.
Avoiding Common Pitfalls in Build to Lease Agreements
The next two sections discuss frequent pitfalls in drafting or executing these key documents, and gives suggestions on how to avoid these issues. Common mistakes and missed opportunities include: 1. Missing deadlines, and the importance of deadlines in these documents. Again, missing a deadline could be an event of default or could prevent a party from getting a remedy. 2. Not addressing mechanics lien issues. Key responsibilities are allocating responsibility for paying subcontractors and suppliers, making sure that all contractors and subcontractors pay their own bills and ensuring that the work is paid for. Without trust receipts and methodologies for preventing liens, a landlord can find itself facing a lien by a general contractor for work that is not necessarily part of the leased improvements and a construction manager can find itself in breach to a landlord where a lien affects the leased property. 3. Issues with subordination, attornment and non-disturbance provisions. A landlord should use what we refer to as a providence clause, requiring a tenant to recognize all leasehold mortgages and allowing the landlord to use available security deposits. A tenant should cooperate with the landlord on project finance. A lender wants the right to step-into the shoes of the tenant and have a new lease drafted so the lender can assume operations after taking title to the property through foreclosure. An agreement not to disturb the tenant in possession in the event of foreclosure is a tenant benefit. A borrower or tenant can negotiate a subordination, attornment and non-disturbance agreement (SNDA) to get the benefits of a limited unilateral nondisturbance, where the tenant does not have to perform and the total mortgage documentation encumbers the property.
Examples of Successful Build to Lease Ventures
We have already mentioned the journey of TIER REIT and how they have benefitted from build to lease projects. We will take a look at three more examples to illustrate the success of build to lease transactions for operating companies, and the land developers.
In 2015, Cawley Partners, an office developer, struck a deal with Hines to develop a five-story office building on a 25,817 square foot parcel of land in Tysons Corner, Virginia. The parties entered into a build to suit agreement whereby Hines would lease the property for 10 years with three 5-year options at Hines’ discretion. The construction cost was $21 million and the building included 60 parking spaces and over 235,000 square feet of office space.
JPI, an apartment developer, also utilized a build to lease agreement for its Austin project . JPI entered into a build to lease agreement with a subsidiary of Ohio State Teachers Retirement System to build a 475-unit apartment project in Austin, TX. The project is being developed on 5.33 acres of land and is expected to be completed in 2017.
Piedmont Office Realty Trust, Inc., a REIT, also utilized a build to lease agreement to construct Oasis, a 307,000 square foot, LEED Gold-rated office project located in Orlando, FL. Oasis is one of the largest speculative office projects in Central Florida. Piedmont entered into a build to lease agreement with Al. Neyer, which is a developer of office and industrial projects. Piedmont also brought Lend Lease on as construction manager for the project. Although the project broke ground in October 2013, it was only 30% leased. The demand for space at Oasis ultimately caught up with the leases and by the time in opened in October 2014 it was 79% leased.