Leases, From a Developers Point of View

A look at landside multi-tenant development and what makes it work, or not


In going over the outline of an airport project with Mr. John Yarberry, Senior Vice President-Real Estate for Wells Fargo, it became clear that for a bank like Wells Fargo to even consider project financing for an airport project they would want to see the following:

  • Ideally a term of at least 50 years. If not that then a term that extended at least ten years beyond the end of the amortization period of the loan. If it’s a 25-year loan then they would want a 35-year lease.
  • Defined land rent escalations. This can take several forms, but doesn’t include at the sole discretion of the airport.
  • Relocation provisions that ideally would provide enough compensation to retire the loan, even if the developer lost all equity.

Additionally Wells Fargo would expect to underwrite the loan based on standard requirements like a 1.25 debt coverage ratio (income after expenses that is 1.25 times the debt service payment); a maximum of 70 percent loan to cost in the beginning (on a land lease 70 percent might be a stretch), and the maintenance of 70 percent loan to value over the life of the loan. A lot would depend on the bank’s relationship with the developer, his track record, other assets, etc.

In other words, not an encouraging start since many airports want as short a term as possible, and the more equity one has in the project the harder it is to realize an acceptable rate of return.

There are many important provisions in any land lease such as access, signage, offsite work, construction standards, and many others, but the following seem to be the potential deal killers ...

Item #1: Length of the lease

Probably the single most important item in the entire deal is the length of the lease. Some airports seem to have a goal of keeping the term as short as possible, and the developer, of course, wants it to be a very long term; at least 50 years or more.

On my first airport project we started by pushing for a 99-year lease and wound up settling for 20 years with no renewals (never again!).

I watched a large airport go to market with a request for proposals (RFP) that required a $3.5 million structure to be built by the successful responder. The airport required well over one dollar per square foot for land rent, 10 percent of gross revenue, and a 15-year lease with no renewals.

(The developer is thinking: WHAT? They expect me to build the building, finance it over 15 years, get it paid off, and then GIVE it back to the airport. So they can do what? Go out with another RFP and let me compete for my own building and pay for it all over again. Forget it!

The airport may be thinking: This sneaky developer wants to tie up our land for a long period of time while paying minimal rent and making a lot of money because of the traffic we are bringing to the site. Forget it!)

And in this case that is what both parties chose to do — forget it. There were no responses that met the airport’s terms. Interestingly enough, even though it was a good and unique use, the airport dropped the entire thing instead of considering a modification of the RFP.

Financing

The developer has to build the building; lease it for enough to cover the loan, expenses, risk of tenant failure/vacancies, etc.; and still achieve a decent return on equity. This basically requires the end-user to pay rent that is higher than if they were able to build the building themselves and lease the land directly from the airport.

How do the lenders look at this? They really want to look the other way and do business somewhere else. Finance something where there is a residual value to the project and it may be more valuable over time as opposed to it becoming less and less valuable as the lease years go by. There is nothing to like from a lenders point of view.

The lender is probably wondering why the developer is even trying to do this deal when its on an un-subordinated land lease, vague language regarding land rent escalations (if it’s that good), no renewals, and relocation provisions that altogether makes one want to faint.

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