The New Wave of Industrial Assets
The industrial real estate market is experiencing high transaction activity, historically low vacancy rates, and a robust development pipeline across the U.S. With the sector’s growing popularity came the trend of build to suit facilities, offering a new way to develop industrial spaces that immediately fit the needs and wants of the tenant. As traditional industrial assets become harder to source, investors and operators are looking for different opportunities. So, how did build to suit enter the market, and what is its effect on commercial real estate?
What is Build to suit?
A build to suit (BTS) facility is produced when a commercial property tenant agrees with a developer or landowner to construct a brand new, custom-built facility for lease. Once built, the tenant typically becomes the sole occupant of the space. Developing a BTS property is complex in that it involves more than one agreement, a construction and lease contract. When moving forward with a build to suit project, both contracts are signed simultaneously. As established real estate becomes scarce and sale prices increase, businesses seek new opportunities and ways to expand their industrial footprint. Build to suit allows a company to build a space with all necessary infrastructure and technology in place instead of finding a property that suits the operations.
There are two main ways to obtain a BTS facility:
1. Developer Route
The tenant hires a commercial broker to market their deal to developers. After the tenant chooses a developer, the developer then takes on acquiring the land, building construction, and property management. The tenant leases the space upon completion, typically for ten years or more.
2. Sale Leaseback Route
The tenant is responsible for the financing, land acquisition, contractors, planning, etc. Upon completion, the building is sold to an investor, with the tenant remaining the occupant. This scenario allows the tenant to liquidate the property’s capital and reinvest into the business.
Both routes offer advantages and disadvantages. It’s important to speak to a specialized real estate broker to determine the most suitable build to suit plan within the desired budget and long-term business goals.
- Capability to determine design and overall construction goals and functionality
- Ability to select location to enhance functionality
- Opportunity to depreciate the building while avoiding capital gains taxes
- Ability to incorporate latest technology and make the building more sustainable/energy efficient
- Freedom to lease out additional space to other tenants or expand operations
- Inability to commit for a short-term, most contracts are ten years or more
- Require plentiful capital as they are expensive and depend on excellent credit for financing
- Require a longer development timeline that can take several years to finish
Built by Popular Demand
The demand for industrial real estate has feverishly grown over the past few years, with e-commerce accelerating the need for more space faster. COVID-19 greatly impacted global supply chains. The after-effects have encouraged companies to plan ahead more, with many increasing their inventory to a 60-day supply compared to the 30-day supply traditionally made, increasing the urgency for warehouse investments and shipping fulfillment centers. As companies compete for established properties, sale prices and rent rates rise, in turn making ground-up development more intriguing. Build to suit development attracts companies looking to put capital into a long-term investment that suits their business operations without expensive renovations to an existing building.
Although extremely popular, BTS facilities work better for some companies than others.
The asset type usually fits well-established businesses with a long track record. These types of companies typically have the capital and staying power to make a long-term commitment, such as the ten-year lease terms BTS properties often require.
Established businesses can also confidently lay out their expectations for contractors and design as they’ve been successfully operating with a set system for extended periods.
Amazon spent an estimated $25.4 billion on leased property and equipment and $5.8 billion on build to suit development of fulfillment centers in 2021. Source: GlobeSt
Some markets are experiencing heightened build to suit development. With access to international shipping waters, port markets are the best performing BTS markets as existing buildings for lease or sale are hard to come by.
Rural areas, especially in the Sunbelt region of the U.S., offer more land for development than denser coastal markets. Land availability has encouraged build to suit development in the area, and many Sunbelt states offer business-friendly government policies.
Looking to the Future
As with most commercial real estate sectors, build to suit is facing the challenge of rising construction costs and inflation. The heightened cost for necessary building materials and appliances has slowed development across the country, working against hasty demand. Tenants and developers will need to create a streamlined approach after the contract has been signed to ensure all costs and timelines have been accounted for.
Build to suit is one of the industrial real estate’s most popular emerging trends, allowing tenants to build their space tailored to their real estate needs. Increased competition for established properties is predicted to continue while consumers drive demand for more buildings faster than they can be built. Companies will need to find different solutions to expand quickly and efficiently, and with scarce leasing options, build to suit seems to be the answer.