Site Selection in a Build-to-Suit Project: Should the Land and Developer Be Selected Separately or Together?

05 November 2014 Publication
Site selection is a critical issue in build-to-suit (BTS) projects. There may be nothing more important to the success of a build-to-suit project than its location. Factors such as the strength of local labor markets, the quality of transportation infrastructure, and the proximity to suppliers, customers and existing employees are all fundamental to business operations. In addition, the size and shape of the land parcel and how the building fits on it, the potential for expansion, the status of entitlements and land cost all impact the functionality and overall success of the project.

As the tenant starts to identify specific land parcels suitable for its project, the tenant will find that two approaches to land are commonly used in build-to-suit projects. In the first, the prospective developer controls the land, usually in a partially developed corporate park (“Park”). In this approach, the land and developer come as a package. The tenant cannot put its building in that Park unless the tenant uses the Park developer.

In the second approach, the tenant finds a suitable parcel owned by a third party who has no interest in developing the land. The tenant can control the land by putting it under contract with the third party owner. Once the tenant has selected its BTS developer partner, the tenant will assign the land purchase contract to the developer, who will buy the land, construct the project and lease it to the tenant. In this approach, the land and developer do not come together.

Both approaches have advantages and disadvantages. Significant advantages of the existing Park include faster and more certain completion and better pricing certainty. Entitlements, which are a major risk factor for the Project Schedule, should be mostly complete, which makes for a faster and more certain Project Schedule. The developer should have a good sense for infrastructure, site development and building costs, due to its prior experience in the Park, which will reduce pricing risk and also help achieve timely completion. Another advantage is that the Park is controlled by the developer, so the look and feel of the “neighborhood” are predictable. Finally, because the developer already owns the land, the risk of a third-party land owner forcing a premature land closing is alleviated.

However, when the developer and land come as a package, there are also disadvantages. An important disadvantage is the lack of competitive pricing. If the tenant wants to be in that Park, it has to pay the land price demanded by the Park developer. The tenant will not be able to competitively bid one developer against another, so the tenant has less ability to negotiate the best developer deal. Also, the developer may have already exhausted any available governmental incentives, which means they will not be available to the tenant. In order to protect its interest in the Park, the developer will exercise more control over design and use of the building and may impose unwanted use limitations. Finally, the tenant will have fewer location choices.

Key advantages to the tenant of acquiring the land from a third party are reduced cost and greater flexibility. More land choices will be available, so the tenant can create price competition among land sellers thereby reducing cost. More land choices will also yield greater flexibility on parcel size and location. Since the tenant is not locked into a single developer, the tenant can create price competition among prospective developers and thereby negotiate the best developer deal, including the lowest rent constant (aka lease constant). In addition, any governmental or other economic incentives will accrue only to the tenant. Finally, the tenant can protect itself by controlling the land. If the relationship with the developer becomes rocky, the tenant can change developers any time before the land is purchased, which allows the tenant to retain negotiating leverage. That is not an option when working with a Park developer.

Acquiring the land from a third party can create significant issues with the Project Schedule and the Budget. The timeline for entitlements will be more uncertain. Requirements for off-site infrastructure may be less clear. If additional infrastructure or site improvements are required the construction schedule will be more subject to seasonal limitations. Utility availability must be confirmed and enhancements may be required, also causing delay. In addition to Project Schedule concerns, the cost of site development and building construction may be less certain because the developer has not developed other land parcels in the immediate vicinity.

Finding the best approach to a build-to-suit lease is more about trade-offs than it is about a particular approach being inherently right or wrong, and that is certainly true in site selection. Tenants that value being in an established corporate Park, want to minimize the hassle and risk of a build-to-suit and are willing to pay a premium for those benefits, may be better served by locating in an existing Park and using the captive developer. On the other hand, tenants that have sufficient in-house real estate expertise, want added flexibility on site selection and design control, and for whom lower cost is important, may find that controlling the land themselves and having developers compete for their build-to-suit lease is the preferred approach.

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