Friday, July 1, 2022

No buildings available? You may need a build-to-suit

Negotiations are ongoing as we have a signed letter of intent for a large logistics building outside the Southern California Basin.

Our client is planning to expand his operations at this location. The greed of less expensive land and less restrictions in the city kept us hooked. The lack of supplies affected us almost until we decided to buy land and build. It is also called “build-to-suit”.

Recently, we sold a building outside the state of California. Our client is an investor who has purchased a Texas building on a tax-deferred exchange.

The cash flow, ease of management and multi-year lease appealed to the buyer. For the next more than 10 years, our customers will enjoy paying rent.

The building has been leased to a Fortune 500 company for a long period. A build-to-suite was completed for the tenant four years ago.

So, what is build-to-suit and when should it be considered? I believe that one or more of the following circumstances will dictate buying or leasing of new construction versus existing building.

lack of availability

Industrial vacancy in Orange County is the lowest in history. About 99.5 out of every 100 manufacturing and warehouse buildings are occupied. And if your wish is Class A, in many cases there is no supply. If your company needs to grow into a large building, chances are you’ll be hard pressed to find one.

The paucity of available buildings should suggest a good climate for the construction of the suit.

The trouble is, there is very little undeveloped land in the county. Even if you want to build, no vacant land exists to accommodate such a feat.

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In the case of the Texas building mentioned above, there were no vacant buildings within the desired city, but there was a surplus of affordable and available buildable land sites. Thus, the alternative was to build or consider another city.

special purpose building

This is similar to the “lack of availability” situation, yet very different. If you are patient, and there are occupied buildings in your market, eventually someone will collapse, creating a vacancy and needing a new occupant.

A special-purpose building has features that are not present in the market such as a warehouse with 40-foot ceilings or a building with one acre of additional land for outdoor storage, perhaps to store highly combustible or explosive materials has been created.

Our Texas building needed two of these: very high ceilings and acres of additional land for expansion and trailer storage.

A unique deal structure

Until recently, a grocery distributor was required to have a Class A warehouse the size that did not exist in the city they wanted.

Additionally, the occupier wanted to own, but could not afford to buy land, build buildings and take loans on the under-construction building, which they could not occupy until completion.

The solution was to detain a developer who bought the land, constructed the building, leased the building to the grocery distributor and gave the occupier the option to purchase the building once it was completed.

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But, beware of the following issues.

lots of lead time, Few if any occupants can predict that their location needs a move two to three years before it is. However, you should spend that much time completing the build-to-suite.

Complete understanding of mechanics. The basic structure is: land owned or purchased, new construction planned and permitted, building constructed and new construction occupied. easy, isn’t it? Yes, if you have land, already planned out and granted permission, have a bucket of cash to spend on construction, and don’t need a building for several months. Complexity is added with each unchecked box.

financial qualification. You need to understand how build-to-suit financing works. I could write an entire column on the subject, however, there are some highlights: Vacant land will usually have to be bought with cash, a construction loan will precede a permanent loan, may require some appraisal, landlords will not do their Allow the loan (if made by the seller) to be junior to a construction loan. Are you confused yet? Absolutely! This is no ordinary transaction.

Understanding you will pay more. I encourage you to take a look at the reasons you would pay more to occupy an existing building versus a new one. In short, the reasons include land prices, soft costs, rights, time value of money, financing, economies of scale and market forces.

Alan C. Buchanan is principal of Lee & Associates Commercial Real Estate Services in SIOR, Orange. He can be contacted at abuchanan@lee-associates.com or 714.564.7104.

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