Build to Suit

By Steve Gillman - 2005

With a build-to-suit project, you can generate good cash flow from reliable tenants. Be ready for this one though. Your land can sit empty for a long time.

The basic concept behind a build-to-suit deal is that you invest only in the land until you find a long-term tenant. Then you build whatever the tenant needs, after he signs a lease that assures you you'll have positive cash flow. The tenant is happy, you are happy, and the bank is ready to finance the construction as soon as you show them that ten-year lease.

These things can take time. You have probably seen a vacant lot with a sign that says "Will Build To Suit" or something similar. And you have probably seen the same sign on the same empty lot six months or even a year later. This is obviously not a get rich quick plan.

The good news? It can be relatively inexpensive to hold onto a vacant lot while you are waiting for that perfect tenant to build for. If you paid cash for the lot to begin with, you have only the cost of the property taxes and whatever advertising you choose to do. Besides, if the average rental has gone up $50 while you are waiting, you can even make $6,000 extra from that 120-month lease.

A Build to Suit Example

Suppose you bought a small lot in a commercially-zoned area. There have been several new buildings put up along the same street in the last year or two, housing businesses ranging from a drugstore to a car-parts store. You paid $115,000 for the lot, and you put up a sign saying "Will Build To Suit With Long Term Lease."

A few months later you meet a business owner with a successful tanning salon on the other side of town. He wants one here as well. You get together with him and a builder, and get a quote for the building that he will need. Because the building will be generic enough that it will be easily converted for use by future tenants with other types of business, you agree to just a five-year lease.

After checking out the owners references, and maybe even looking at his books to see that he is doing well financially, you decide that he would be an excellent tenant. Your total cost including the land, the holding costs, the new building and everything you can think of to include will be around $300,000. You talk to your banker, who gives you pre-approval for a loan of $240,000, contingent on a good lease showing sufficient income to cover the debt service and other costs.

Your loan payment will be $1,600 per month. The tenant has agreed to a triple-net lease, meaning he will pay for property taxes, insurance and maintenance. That means you will essentially have no expenses for five years except for the mortgage payment. You negotiate a rental rate of $2,800 per month. This, along with the other expenses paid by the tenant is slightly above the going rates, but he will be assured of no rent increase during the five years.

Once the place is built and the tenant is in there, you'll have about $60,000 of your money invested, and net income of about $14,000 per year. That's a cash-on-cash return of around 23%. With a triple-net lease, you will also have none of the usual headaches of being a landlord.

You can see how these build-to-suit properties can be an attractive investment.

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