Documenting Your Build-to-Suit Transaction: The Importance of the Request for Proposal
The Request for Proposal (RFP) is a critical document in a build-to-suit (BTS) transaction, but often does not get the attention it deserves. In addition to laying out the project scope, the RFP is the tenant’s opportunity to clearly set forth its expectations early in the process and to signal that a collaborative process is desired. Developers are more willing to agree to key lease provisions favorable to the tenant in the RFP process than they are in lease negotiations. Avoiding requests for concessions that are disproportionately burdensome for the developer, when such provisions are not truly important to the tenant, helps to facilitate a collaborative process and timely completion.
The RFP should describe the nature and extent of the project, the desired location, and the expected timing of completion. Developers should always be asked to bid on the rent constant used to determine the annual rent (sometimes called the lease constant), the developer’s fee, and the amount and use of contingency funds. The developers should also be asked to bid on any items of particular importance, such as rail access, 24-hour operation, allowances and extent of permitted change orders.
If the tenant is not a public company, it should give financial statements to the developers with the Request for Proposal because the rent constant will be based on tenant credit. If the tenant does not prepare financial statements, the tenant should be prepared to provide a lease guaranty from an entity that does (usually its parent). When the tenant volunteers its financial statements and, if appropriate, a guaranty of its parent, the tenant signals its understanding of the importance of credit and that it expects the best possible economic terms.
A well drafted RFP establishes certain key points that developers often compromise on in the RFP stage, but will resist during lease negotiations. The BTS lease will be drafted by the developer’s attorney and will create a baseline tilted to the developer. The RFP is the tenant’s best opportunity to level that baseline. A few extra hours on the RFP can result in many hours saved in lease negotiations. For example, budgets have a line item for contingency. If the use of the contingency funds is not addressed until lease negotiations, the developer will likely take the position that it controls the contingency and can keep any unused portion. When addressed in the RFP, developers usually agree that contingency funds can be used in ways favorable to the tenant.
Another example is the tenant’s right to occupy the building before scheduled completion, not just for fixturing, but to commence business operations. In lease negotiations developers usually insist that once the tenant starts operations in the building, it must pay rent. However, because the cost of interest expense through the scheduled development period is already included in the project budget, if the tenant is forced to pay rent before scheduled completion, the tenant is paying twice. In the RFP stage, the tenant may be able to negotiate for a period of occupancy, to facilitate transition and moving, at a “rent” equal to the construction loan rate, rather than the much higher rent constant.
The RFP can require that once the project is designed and priced with a signed construction contract, the developer takes the risk of contractor performance. Developers will usually agree to this when competing for the project. If first addressed in lease negotiations after developer selection, the developer is more likely to resist. Tenants appreciate this shifting of responsibility, even at a modest increase in cost, because a significant cost risk is removed.
Finally, the terms of any options for lease renewal can be established in the RFP. For example, the renewal option can be set at a percentage of fair market rental, with a required appraisal process. Ninety-five percent of fair market rent should be acceptable to the developer because there is no down time, brokers’ fees or other concessions. Sometimes developers will try to limit renewal rent to no less than the last year’s rent. That formulation is disadvantageous to the tenant and can usually be avoided if addressed in the RFP stage.
Just as it is important to establish concepts benefitting the tenant in the RFP, provisions that are disproportionately negative to the developer should be avoided. Purchase options are an example of this. A tenant might ask for a three year fixed price purchase option without giving much thought to whether or not it is really needed or even if the tenant would ever exercise it. Such a provision is so detrimental to the developer’s economics that such a request might cause other economic terms to be less favorable or even preclude some developers from bidding on the project. Much of the developer’s profit comes from selling its projects when valuations are high and the developer wants to control that process. In the developer’s view, a fixed price purchase option takes away its upside, while forcing it to retain the downside.
Similarly, terms which are extremely difficult to negotiate should be avoided unless fundamentally important to the tenant. An example would be expansion options that require the future expansion of an existing building. Requiring such an expansion option in the RFP should not be done just because it would be “nice to have.” Rather, an expansion option should be requested only if there is a compelling reason for it and then the tenant should be prepared to commit the additional resources to negotiating and documenting that right at the RFP stage.
In conclusion, a well-drafted Request for Proposal should signal that a collaborative process is desired. Many key points can be established in the RFP thereby avoiding hours of unnecessary effort during lease negotiations. To enable developers to respond as quickly and consistently as possible, the RFP should be very clear and should focus on points that are fundamentally important to the tenant. The tenant should be sensitive to the burden placed on the developer by rights such as purchase and expansion options and should avoid asking for them just because they “would be nice to have.”
Although it is easy to think of the Request for Proposal as a merely preliminary document, that would be a mistake. After completing a heavily negotiated build-to-suit lease on behalf of a sophisticated tenant who lacked experience in real estate, I asked the client for his impressions. He responded, “if there was one thing I could do differently, I would pay a lot more attention to the RFP.”
A modified version of this article originally appeared in Real Estate Forum.
