How Prospectus Governs Build-to-Suit Rents

Over the years, we’ve observed that government-leased build-to-suit (or, in GSA parlance, “lease-construct”) projects often seem to price at or near the prospectus-approved rent cap.  We decided to take a look at the trend using the FBI’s field office construction program as our test bed.  We did this largely because the FBI field office Program of Requirements is well-defined and their projects are fundamentally homogenous.

So, we looked at this program and found that, indeed, the equalized rent for many of these buildings was exactly at the prospectus cap figure, or just a penny less.  Does that mean that developers were setting their pricing as high as permissible?  No, in fact the result was the opposite: many developers struggled to justify a financially-feasible project at GSA’s required rent; though, inevitably, someone would figure out a way to get there, just barely.  Some would regard this as “Survival of the Fittest” while others would speculate that the “Greater Fool” theory consistently prevails.  In either case, pricing to reach GSA’s maximum approved rent has often been a challenge.

As it turns out, pricing has been such a challenge that the FBI had to financially assist in several transactions.  The most common means by which the FBI has done this is to agree to pay down the rent by reimbursing the developer, lump-sum, for tenant improvements.  Typically, this amount has been enough to lower the developer’s required rent just enough to reach the prospectus figure. Thus, it is no coincidence that many rents are exactly at the prospectus figure.

One other observation we made when reviewing this data was to note that rents through most of 2011 and 2012 are exactly at prospectus but the leases before and after that period are below.  In some cases the reason is the TI buy-down method described above, or mitigation of certain operating expenses.  However, we theorize that the developers of these projects were also more bullish about the capital markets.  Projects delivering in the 2005- 2009 time period were awarded at least two years earlier, in a much frothier period.  Projects delivered in 2012 were awarded at a time when it was becoming clear that capital markets were improving.  As we will explore in a future article, no factor has a greater impact on pricing than the developer’s exit cap rate assumption.  Therefore, we think pricing in these periods was generally more aggressive.

Final note: we’re sure you recognized that one lease, Tucson, is above the prospectus rent.  It’s an apparent “prospectus bust”.  This isn’t supposed to happen and, in fact, the lease itself includes narrative meant to describe how the contract rent conplies with the prospectus limitation, but the calculation is apparently flawed.