Developing or refurbishing buildings for lease - what is an ‘agreement to design, build and lease’?

Property

In rare cases, a developer may start construction or refurbishment of a building without securing any tenants. In such cases, the developer would need to be confident in the market and have significant capital to finance the build as lenders will generally require a certain level of preleasing prior to providing finance.

More commonly the developer will want to secure an ‘anchor tenant’ or tenants before they commence the design and construction or refurbishment of the building. This will be achieved by entering into an agreement with the tenant or tenants to “design, build and lease” the building to them.

An ‘agreement to design, build and lease’, is an agreement between a landlord and a tenant that provides for the tenant to lease a premises (or part of a premises) from the landlord following design and construction of the premises by the landlord. For the tenant, it will ensure a purpose-built facility, which the tenant will then be able to fitout to satisfy its needs. Alternatively, the landlord could undertake those fitout works for the tenant as part of the construction process. For the landlord it will help provide the necessary tenant commitment and construction detail that the landlord requires to commence construction.

The ‘agreement to design, build and lease’ (Agreement) can take various forms. It could be a bespoke agreement drafted by the parties’ solicitors or, as is often the case with smaller buildings, using the Auckland District Law Society’s form of Agreement to Lease with an extensive set of further terms added to cover all facets of the design, construction and lease.

Some of the more important terms that are usually included in the Agreement are discussed below:

Conditions: The Agreement may need to be made subject to either party satisfying certain conditions before it becomes binding on both parties. The conditions will ultimately depend on the stage of the design/construction and requirements of the parties. The landlord will often require the Agreement to be conditional on obtaining resource and building consents together with finance to complete the build. It may also be conditional on the tenant approving the landlord’s plans for the premises and/or the landlord approving the tenant’s fitout plans.

Dates: The Agreement usually includes a number of important dates.

  • The ‘access date’ is the date that the tenant will gain access to the premises to start its fitout and is typically subject to the project manager or architect confirming that construction has reached a certain stage.
  • The commencement date is the date that tenant’s lease of the premises will actually commence. This is generally tied to ‘practical completion’ of the construction of the premises and issue of a code compliance certificate or certificate of public use.
  • Some Agreements include a sunset date by which ‘practical completion’ of the construction of the premises must be completed. If for any reason construction has not been completed by this date then the tenant can cancel the Agreement.

Landlord and tenant works: The Agreement will specifically set out the work to be completed by the landlord (construction of the premises) and any work to be completed by the tenant (i.e. fitout of the premises). These clauses will set out the standard of construction required and other relevant details with reference to the plans and specifications for the build. The Agreement should consider how any variations to the plans and specifications will be dealt with and how and when any required remedial works will be carried out. These are key clauses in the Agreement and need to be well thought through to avoid conflicts.

Term: Landlords entering into an Agreement often require a substantial initial lease term reflecting the landlord’s investment in the premises. This will obviously be a matter for negotiation between the parties and can vary markedly based on a number of factors.

Rental: The simplest way to provide for the rent payable under the lease is for the parties to agree a flat rental to apply prior to signing the Agreement. Often this will be in the form of an agreed $/m2 rate, with the actual rent to be determined by a final measure following commencement of the lease. In some cases, the parties may agree a rental based on the cost of construction or a base rental which is subject to a market review immediately following commencement of the lease.

Tenancy inducements: Some form of tenancy inducement may be required to secure the tenant. The quantum of the inducement can vary significantly and will depend on who has the market power at the time. Inducements can take a number of different forms, the most common being a ‘rent free’ period during which the tenant is not required to pay rent. Others include contributions to fitout and capital payments.

Form of deed of lease: The Agreement will often include a schedule with the form of the Deed of Lease (Deed) to be signed by the parties following commencement of the lease. The Deed is usually a standard form Deed amended to incorporate the parties’ specific requirements or in some cases a bespoke form of Deed prepared by one of the parties (typically where a party has a specific form of lease that they require).

Conclusion ...

An ‘agreement to design, build and lease’ is a complex document that must consider and account for all aspects of the development process in addition to the lease terms. If the parties’ obligations and expectations are not clearly and concisely set out then this can result in ambiguity and lead to costly disputes in the later stages of the development. The best way to prevent any potential issues is to contact our commercial property experts early in the development process.

If you are considering a new development or refurbishment of an existing building for lease then please contact our expert commercial property team so that we can guide you through the legal aspects and assist with documenting the terms of the Agreement.

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