Build-to-Suit (BTS) developments have become a cornerstone for net lease investment models within the tenant-centric market. BTS is likely to assume a pivotal position in shaping the net lease market in 2024, offering tailored solutions to meet the specific needs of quality tenants. Implementing such a strategy may incur significant costs in exchange for building an integral part of the tenant’s core business. The importance is placed on creating lasting relationships between tenants and properties in the challenging real estate market ahead.
Build-to-Suit Approaches
Build-to-Suit is a strategic investment model to design and construct a property to satisfy unique requirements of a specific tenant. Unlike traditional lease arrangements where tenants adapt to pre-existing spaces, BTS allows a tenant to collaborate with the landlord and developers to create a space tailored to individual business operations. This customization extends beyond just physical structure, comprising features such as layout, infrastructure, and even specialized equipment.
BTS is attractive for tenants because it ensures workspace is efficient and functional, leading to increased productivity and operational effectiveness, plus reducing future expenses. One prime example is in the healthcare field as specialized facilities are constructed to accommodate strict guidelines of medical practices, ensuring compliance with regulatory standards and providing a conducive environment for patient care.
From the investor’s perspective, securing a tenant through this model results in a longer lease term which is one of the main benefits for investing in net lease. This stability in occupancy provides steady and reliable cash flows, contributing to overall portfolio performance. Investors capitalizing on this trend by offering customized solutions to healthcare tenants are achieving sustained success in the market. Reversing the BTS process and allowing the tenant to control construction is another popular trend in the last year, releasing the investor from development responsibility. In 2023, most new retail construction devoted to BTS net lease properties will be in promising locations with advantageous demographics.
In 2024, we will see more investors follow net lease BTS for credit-worthy healthcare tenants. The aging population and advancements in medtech continue to drive demand for healthcare services, leading to an increased need for purpose-built facilities. Investors who capitalize on this trend by offering customized solutions to healthcare tenants are likely to experience sustained success in the net lease market.
Construction Considerations
Constructing a suitable property for tenant’s specific needs is evidently more expensive than reconstructing to lease 2nd generation space. Although problems in supply chain from the pandemic have subsided, construction costs remain high due to increased inflation and labor costs. Coupled with a slowdown in capital markets, costs to build are subject to high interest rate, therefore lack of financing. Despite economic shortcomings, BTS deals under similar market conditions have historically performed well in the long-run.
BTS can open more financing options than acquiring the traditional commercial construction loans and refinancing with a bank or CMBS loan. Investing in BTS projects provides options to seek credit tenant lease (CTL) financing, offering BTS construction loans with long-term solutions. CTL is known to secure lending at lower interest rates and longer amortizations. Leveraging credit-worthy tenants to obtain loans enhances cash flow performance and reserves investors’ capital.
Conclusion
It’s essential to weigh the risks associated with Build-to-Suit investments aside from the considerable time and costs. Investors must evaluate the potential vacancy as property may not provide a quick occupancy turnover in the event the original tenant evacuates. Because of this, forming a strong connection between occupants and their premises is key for long-term leases and stable income for investors. As the demand for specialized facilities continues to rise, the synergy between Build-to-Suit and net lease investments, particularly in the healthcare sector, presents an attractive proposition for both tenants and investors to work with real estate professionals in understanding the dynamic market.
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