In the boom and bust markets of Perth and Brisbane, industry activity has been bolstered in recent years by speculative devel­opments. However the current financial hiatus is likely to bring reality back into even these markets and total or substantial pre-commitments will be required for any project to come out of the ground.

 

On the demand side, for large-end users – if there are no existing development remnants that they can back-fill at ‘screaming’ lease deals – the only way to secure large tracts of accommodation to meet consolidation needs will be through pre-commitment deals.

 

But these deals can be challenging to assess. Will the project happen within the required time-frame? Will the completed building meet design and performance requirements?

 

At proposal and tender stage, developments will be marketed by glossy brochures, concept plans, umpteen perspectives, interactive presentations and virtual “fly-through” models. All this collateral will expound the benefits and attributes of new, better, more innova­tive and more environmentally friendly developments. With devel­opers suffering from over-priced development sites and over-geared balance sheets, desperate measures will be used to get developments pre-committed – the precursor to obtaining finance. And over the next few years, expect to see previously stalled projects taken off the shelves and dusted down for presentation time and time again.

 

Prospective pre-commitment tenants need to hasten slowly as they proceed through technical, commercial and legal due diligence to make sure that they do not get caught out.

  • Beware of short-listing a development that is not bankable
  • Be careful not to lose competitive negotiating leverage too soon
  • Do not assume that initial presentations of projects that comply with all your specific needs will be delivered without changes.

 

It may be advisable to work with the mind-set that the standard qualification to all developments should be: “Any resemblance between the final building and the development perspectives, models and concept plans is merely coincidental.”

 

Based on the usual evaluation criteria and development funda­mentals of location, design, critical requirements, key lease condi­tions and commercial terms, the pre-commitment lease process is usually quick to reduce the long list to three or four credible options. At this stage the detailed due diligence should commence.

 

Coming out of this process, there must be good understanding covering the key questions before the short-list is reduced further– particularly as this moves a development to the magical preferred development status. At this point, negotiating leverage suddenly disappears. Any design and specification uncertainty now tends to become totally vague – to the developer’s advantage. If a major glitch is encountered, it may be possible to revert back to one of the other short-listed developments, but this has complications and can be very embarrassing.

Putting aside the commercial and legal negotiations for the moment, the main risks can best be framed in the following key questions:

  • Does the developer really control the subject site and does the site have the planning rights?
  • Will the developer, professional consultants and builder be able to deliver the project within the committed timeframe?
  • Will the final building and accommodation meet the defined brief?
  • Can the project be financed?
  • Will the building and landlord’s performance meet expectations?

The risk assessment and due diligence process can be split into five key components.

 

 

Site and planning risk

Often site tenure and control of sites are assumed, but surprises can occur. Adverse title conditions, consolidation problems, heritage restrictions, site contamination and impediments such as existing leases and agreements have been known to cause significant unex­pected delays. And development approvals conditions and restric­tions may mean some representations will not be delivered. Too often the status of development approval is glossed over to win preferred status. It is therefore prudent to spend time and effort sighting original documentation.

Building specification and performance risk

Certainty of design quality and building services performance is a critical risk area for buildings yet to be constructed. At the proposal stage, specification detail can be very sketchy and certainty of the final product is seldom available. Detailed technical due diligence of the project’s ability to achieve performance standards as promised is essential.

 

With environmental performance becoming all important, design detail assessment has become more complex. Once the building is completed and occupied, the tenant’s remedy for non-performance of the building and services can be challenging – both legally and commercially – for all parties.

Feasibility and financing risk

In the current financial climate, understanding if a project will be able to secure the required finance has become all-important. There are now regular anecdotes doing the rounds of the industry about fully pre-committed projects not securing the required construction and take-out finance. Despite obtaining undertakings from devel­opers that funding has been secured, it is prudent to sight original funding documentation – and understand all the related conditions.

 

The financing issues appear to be primarily related to the amount and availability of equity finance, linked to the key development feasibility assumptions.

 

In many cases, these assumptions seem to be based on out-dated property market inputs with low target developer margin, aggressive loan-to-value ratios and excessive incentive levels. In negotiations, beware the “screaming” rental and incentive deal for an un-started development – it will probably not be able to obtain finance and will never get out the ground.

2009

 

Program and delivery risk

Programming and delivery risk usually loom large as the critical commitment stage arrives. Decisions always seem to take longer than expected, exacerbating the risk of running past a lease expiry date.

 

The project sponsor and developer track-record is critical. Evidence of prior developments completed – of equivalent size and complex­ity – can be comforting, but equally important is the professional team’s experience and capability.

 

In essence, is the project time-line realistic, based on market conditions and past performance? Make sure there will be sufficient time to buffer your exit from your existing location and undertake lease make-good obligations.

 

Landlord harmony and occupancy risk

Even if the financing and delivery plan is believable and all other aspects appear to be in place, will quiet enjoyment and relative harmony with the landlord exist once you are relocated to the new building?

 

Tenant obligations in the heads of agreements may provide an indication of occupancy risk and building performance, but the profile of the ultimate landlord – if that is known, because there may be an on-sell strategy – can be crucial to future occupancy enjoy­ment. Has the owner had previous experience with major tenant expectations? What will the approach of the owner be to tenant relationships management?

 

Pre-commitment leases for new developments are far more complex and risky than relocations to existing buildings or partial­ly completed developments. The best advice is to do the detailed homework to test all representations; do not push the commercial deal too far; and remember, after moving into the new building, the relationship with the landlord will probably have to last for 10 years plus

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