LEASE AGREEMENT REFERENCE GUIDE 1650: NEGOTIATING STRATEGIES FOR THE BUILD TO SUIT LEASE $24.95
Negotiating Strategies for the Build to Suit Lease
This LARG looks at the build to suit lease deal. Build to suits often present uncertainties about the amount of rent payable by the tenant because it is often based upon the ultimate development costs for the space. This means such leases often must contain rent adjustment clauses tied to construction costs, and comprehensive provisions concerning plan approval and bidding procedures for the work. Numerous sample build to suit lease clauses appear in this LARG.
Pegging the Rent to Development Costs
What happens when a commercial landlord is lucky enough to find a single tenant wanting to lease all of the square footage in a building the landlord has on the drawing board? After the landlord stops celebrating, it must negotiate a build to suit (BTS) lease and manage the construction of the building and the leasehold improvements. The new tenant will likely have major leverage, and will want to know its total rent bill up-front, as well as the amount of square footage contained in the building and its proposed level of finish and amenities.
Sometimes in a BTS deal, the plans and specifications for the building are partly or totally complete. Depending upon the stage of development, the landlord may have already signed a construction contract with a guaranteed maximum price from a contractor for the building. If the developer is not that far along, it may have bids from selected contractors, or only estimates of the total development costs. How do the parties compute the rental payable by the tenant if the business deal pegs the rent to actual construction costs?
One approach is to use a formula rent clause, or an “up-down” rental clause, as it is sometimes called. This allows the parties to sign the lease with a rental subject to possible increase or decrease based upon how total construction costs turn out when the project is finished. It is normal for such increases or decreases to be capped, or otherwise subject to some sort of limitation.
Development Cost Ingredients
Of course, actual costs of construction, frequently referred to as “hard costs” must be included in development costs. But with other sorts of costs related to the work, it is not so obvious whether or not they should be included when computing development costs. Both the landlord and the tenant should carefully review the definition of development costs in their BTS lease to decide if the following items should qualify as “development costs”: