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Build-To-Suit Properties

Published On 05-29-2013 , 3:15 PM

Wouldn’t it be nice if all your assignments were as straight-forward as the appraisal of a build-to-suit Walgreens? Everything is contracted and revealed for analysis. You know all the parties involved: the developer who puts the deal together, the top-quality national tenant, and the ultimate purchaser who gets a steady and reliable income stream. Plus, there is plenty of data, because Walgreens and their main competitor CVS are still popping up in new places around the country. Plenty of construction data, plenty of sales, and plenty of rent comparables. Better yet, the comparables are exact replicas of the subject. To top it all off, you have the best supported cap rates of any property type. In appraiser heaven all our assignments will be built-to-suit properties; or will they?


First of all, I imagine it would be pretty boring to value the same property type over and over again, with nothing to break up the tedium. Second, build-to-suit assignments may not always be as straight-forward as advertised. It turns out that The Dictionary of Real Estate Appraisal does not include a definition of build-to-suit. As a result, there are times appraisers mistake properties that are not build-to-suit for ones that are and instances when the reverse is true.


If I were creating a definition for build-to-suit I would start by stating what it is not. Built-to-suit is not analogous with any proposed property or a recently completed one. Something is not build-to-suit just because it is unusual or a particular property type. The key determiner for a build-to-suit is service, rather than self-sufficiency. There are at least two players involved: the entity that needs a new facility and the entity that will provide the needed facility, for a price. Every build-to-suit is very like a hand-tailored suit. The customer comes into the shop and is measured. His color and fabric choices are determined, along with the desired cut and style. The tailor creates the suit and, when recompensed for his time and profit, the customer walks out of the shop with an ensemble that fits him like a glove.


In the same way, a property is not build-to-suit unless there is a developer and a user. More specifically, the developer is the land owner who creates the improvements to certain specifications and leases the property to the user/tenant. If the developer sells the completed property to the user it is not truly a build-to-suit; the developer just filled the role of a contractor.


In a perfect world, the cost of creating a specific improvement would drive a contract rent exactly equal to market rent for that same property. However, that is rarely the case. Just as cost does not equal value, rent driven by costs is most often different than general market rents for an equivalent property. Since build-to-suit rents owe little to market conditions and everything to site acquisition and construction costs, they tend to exceed market rents. And since the sale prices of leased properties are most often driven by the income stream produced by the lease(s), it should be clear that build-to-suit sales and rents may be different – probably higher –than properties that are leased at market terms or are owner occupied.


You may say, “That is so elementary! Why are you spending so much time on a basic concept?’ Well, the reason, my dear Watson, is that fundamentals can sometimes be forgotten; when that happens mistakes can be made.


The first mistake is to assume that a newly constructed retail store or fast food outlet is a build-to-suit even when it is not leased. When faced with an unleased pharmacy, fast food restaurant, or some other property type that is typically sold as a build-to-suit leased property, the appraiser may be tempted to use sales and rents of physically similar build-to-suit properties as comparables. But if the subject property is not leased it will not sell based on income from a fictitious build-to-suit lease in the same manner the build-to-suit leased properties did. And if the newly constructed pharmacy or fast food restaurant that is not currently leased were to be leased under the present market conditions, it would not be at brand new build-to-suit rents. Remember, the definition of market value assumes a sale of the subject property at market terms – value in exchange – not to the current user – value in use.


Added value from a build-to-suit lease is only relevant for “value in exchange” when there is a market for properties with long-term leases and credit tenants. But without a lease, the value of the subject property to another user or to an investor (with the pharmacy or fast food restaurant out of the picture) is nothing like what it would be with a build-to-suit lease in place.


So yes, it is problematic to value a non-build-to-suit property using build-to-suit comparables when the appraiser mislabels the subject as a build-to-suit property. But it can be just as problematic when an appraiser understands that the subject is not build-to-suit yet values the property using “comparables” that he fails to recognize as build-to-suit properties. I have seen this happen most with restaurant rents and sales. A leased property with a rental rate based on cost and profit, rather than on what can be borne in the market, makes a poor comparable for a property that is either leased at market or not leased at all. A property that sold for the high income stream it brings from a build-to-suit lease is not a true comparable for a subject that is not so encumbered.


So there you have it. As often happens, we appraisers have turned a fairly simple concept into an entirely different set of problems. Too bad every property is not leased to Walgreens.



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