Introduction
In the UAE market where there is still limited A-grade office space (the Dubai International Financial Centre, for example, is currently at around 98 percent capacity) and occupiers often find it difficult to find space which suits their business needs (a number of our clients have struggled to find sufficiently big floor plates in their preferred locations), there has been a rise in the number of occupiers looking at the build-to-suit route in order to achieve their desired business space, be that office, warehouse or industrial. In this series of notes on build-to-suit projects in the UAE, we will set out considerations which should be considered from the perspective of:
- the occupier (note 2);
- the landowner (note 3); and
- the lender (note 4).
In this first note of the series, we set out a summary of structures which are commonly used for build-to-suit projects as having an understanding of these structural options and the roles of the relevant parties will be relevant for the next three notes in the series.
Developer buys the land upon which it will construct the build-to-suit project
In this scenario, the developer identifies the land plot based on the requirements of the proposed tenant and acquires the plot itself. It would be unusual for the developer to have acquired the land plot speculatively and not in line with a normal build-to-suit developer’s business model. The benefit of the developer acquiring the plot itself is that it has certainty in respect of the land and with no landowner to have to deal with, the transaction should be more straightforward. on the downside, acquiring the land at the outset will be a significant outlay for the developer and present inherent risk. The developer will want to bind the proposed tenant before the land acquisition is completed but will want to keep the deal confidential to avoid the landowner finding out and potentially trying to sell the land at a premium. Also, while there will be no landowner involved, many of the prime office plots are located within master communities, so there is still an overarching party to deal with.
Developer has an option to buy the land upon which it will construct the project
This structure is similar to the above but has the benefit of giving the developer legal contractual certainty in relation to the plot without having to pay the full purchase price at the outset. There would be a price to pay for such option and the option would be for a finite period so there would be certain time constraints around finding a prospective tenant. In a rising market, locking the purchase price in at the option stage will mean that the option becomes a valuable commodity. In a falling market, the developer having the option not to proceed if a suitable deal with a tenant cannot be done, mitigates the developer’s risk limiting the potential loss to the relevant premium paid for the option (which could be sizeable). As with the structure set out above, the developer will want to ensure that the proposed tenant is contractually bound into taking the premises once completed before it exercises its option.
Developer enters into a joint venture with a landowner
Joint ventures are a well-established structure to unlock land banks which may not otherwise be developed due to the landowner not having the requisite expertise or finances to undertake the development. on a typical build-to-suit joint venture, the landowner will contribute the relevant land as its contribution and the developer will provide its expertise and usually some equity investment so the developer has some ‘skin in the game’. The joint venture agreement (JV Agreement) will need to clearly set out the respective exit options of the parties which may not necessarily be aligned. While the developer is likely to want to cash in on the completed project so it has the capital to then invest in further development projects, the landowner may want to retain the income stream if there is a tenant with a strong financial covenant on a relatively long-term lease. The JV Agreement will need to provide for either party to exit the joint venture (potentially using put and call options) and include appropriate dispute mechanisms.
Developer’s options upon completion of the build-to-suit project
Retaining building and leasing to occupier
As touched on above in the context of the occupier’s exit, the developer will have several options - once it has signed up the prospective tenant, throughout construction and following completion. Following completion of the building the developer may decide to retain the building, at least for a period of time, and utilise the relevant income stream from the lease. If, for example, the market is not strong for disposals when the building is completed, if the developer does not require the capital at that point it time, it may well make financial sense to hold the asset for a while. If the developer has this scenario in mind at the outset, the identity and financial covenant strength of the tenant, the robustness of the pre-letting agreement tying the tenant into taking the premises and the terms of the on-going lease will all be of vital importance to the developer’s return on its investment.
Selling the development to investor(s) on the basis of the pre-letting agreement
As set out in the introduction, there is still limited A-grade office space in the UAE and even fewer single ownership whole buildings let to ‘blue chip’ clients. There is increasing interest from investors and funds looking to acquire high-quality, tenanted assets for their property portfolios. A developer who is seeking an early exit from its build-to-suit project may want to ‘cash-in’ by agreeing to sell the project to invertor(s) prior to completion on the basis of the pre-letting agreement with the prospective tenant. In order to mitigate the investors risk, the investor(s) will not usually pay the full purchase price until the development is completed (and ‘completion’ can mean a myriad of things) but the investor(s) will have to pay a deposit, which can vary in amount, to lock in the transaction thus meaning that the developer’s capital is not tied up in the project until completion.
Occupier buys the land and engages developer
The occupier may be comfortable taking on the role of landowner to ensure that it owns it development once completed without necessarily paying the premium which a third party landowner may expect in the scenario set out below. The overall cost of the completed bespoke building should be cheaper in this scenario than in the one below where the occupier buys a completed building but the occupier takes on both the property and development risk. If the land value goes down and/or the project does not go according to plan, there are substantial losses which the Occupier could suffer. Going down this route does give the occupier control in terms of what the plot is and take the landowner out of the question (but not the master developer as there is likely to be one), it also provides a solution where the developer has not got or cannot obtain the funds to acquire the desired plot and the landowner is not willing to develop the land. An occupier for this structure should be comfortable with taking the land onto its books (considering any tax implications) and be well advised by a real estate agent of repute before going down this route.
Occupier buys finished bespoke building
This is the more straightforward structure from an occupier’s perspective where an occupier wants to acquire its build-to-suit premises. Rather than acquiring the bare land and engaging the developer at the outset with all the inherent risks referred to above, the occupier will agree its requirements (notably location) and specification (including level of fit-out) for the building and the key terms on which it will agree to purchase the building following completion. It will then be for the developer to secure the land (by way of one of the three structures referred to initially) and undertake the development. As will be discussed in more detail in the following series of notes, the parties will need to set out clearly what the tolerances are around the specification (if any) and what happens if the premises are not delivered on time. A well-drafted legal contract should mitigate much, but not all, of the occupier’s risk. As the occupier in this scenario is taking less risk and the risk allocation is more on the developer, the overall cost to the occupier is likely to be higher than the above structure.