Real Estate Developers in the construction industry have been advised to adopt the build to suit model to get the commercial space one needs without having to pay for it.
James Maclean, Executive Director of Real Estate Fusion Capital Limited observes that there has been increased talks of oversupply of commercial office space in Kenya.
He says the firm believes that one of the way to solve the time it takes to fill in the office space or sell is by adopting a built to suit model for office space.
He argues that often when a large manufacturer needs a new factory or distribution center, they don’t hire an architect and build it themselves. Instead they agree a lease with a developer who then builds the factory to their specifications.
“We call this “build to suit” development and it’s something Fusion believes will be a major tool in the growth of not only East Africa’s commercial real estate sector, but its economies as a whole,” says Maclean.
Early in March, Cytonn Real Estate ‘Nairobi Commercial Office Report 2017’ observed that increases in office space supply is constraining performance with occupancy rates and prices declining as rents and yields experience slower growth rates.
The report noted that there was “An oversupply of 3.2 mn square feet of office space in 2017 and it is expected to grow by 21.0 percent to 3.9 mn square feet by 2018.”
“Increased supply is constraining performance with occupancy rates and yields declining as rents and prices experience slower growth rates. Based on the supply pipeline, the trend may continue before the market picks up. Despite this, the sector offers attractive returns in selected markets of up to 12.0 percent yields, with 90.0 percent occupancy,” the report added.
However, Fusion Capital says a build to suit model is an alternative that allows the user/tenant to design and customize a new facility to meet the enterprise’s unique space needs without the large up-front capital expenditure that comes with building and owning.
Constructing and owning the building is a good option for very large companies with plenty of up front capital and big borrowing power.
However, some companies would find it difficult to invest so much capital in the building, rather than back into the business, where they are sure to receive a better return on investment.
In addition, business owners may not want the hassle of managing and operating real estate, or being tied to the building if the company outgrows it in any way.
In a build to suit to lease arrangement, a company selects a real estate developer to design and build a customized facility on a preferred site and then leases or buy it from the developer.
How build to suit it works:
A large company (Client) who needs a new commercial space engages a Developer – like Fusion Capital – with a list of what they need/want then:
1. The two parties then pre agree lease terms including a rental rate (usually a percentage of development) and a lease duration
2. The developer and the client then work together to layout and design the ideal space and agree on an exact budget
3. The developer then builds the space and, once complete, the client moves in.
Both the Developer and the Client benefit. These benefits include:
1. The client gets the space they need – by engaging in the design phase, the client can ensure the space being built has everything they could possibly need to grow and grow efficiently
2. The developer avoids tenanting risk – A recent report by Broll Kenya showed that
office vacancy in Westland’s stands at around 29%.
In the build to suit model, developers guarantee that their buildings will be 100% occupied from day 1.
3. The client doesn’t need to raise billions of shillings before they can move – The developer raises the funds to build the building, leaving the client to allocate funds to grow their core business.
4.Alignment of interest – because rental terms are agreed in advance and as a percentage of an approved development cost, both parties are aligned to deliver the space the client needs to the quality they require
The main risk of a build to suit arrangement falls on the developer in the form of counterparty risk.
Counterparty risk in this case is the risk that between the time that the lease is signed and the building is finished, the client could go out of business making the lease worthless.
This is a real problem as a lot can happen over a development period –usually 2-5 years – as we have seen recently in the Kenyan retail market.
As for the client, many argue businesses could save more money by building and owning their own office space.
This might be true for Apple or Coca Cola – who have massive cash reserves – but for the majority of businesses funding development requires capital to be diverted from business development. Hurting them in the long run.
For more information on how your business can use build to suit development, please contact Fusion Capital at: [email protected]