A guide to pre-lets

What is a pre-let?

A pre-let is a contract between a potential tenant and a commercial property developer which allows the tenant to agree to lease a building before the construction has started. Most likely to occur when there is a shortage of commercial property buildings on the market, entering into a pre-let holds both pros and cons for the parties that are involved.

Reasons why tenants enter into a pre-let agreement

Pre-lets are usually favoured when a tenant can no longer find a suitable property in their search area. The advantage of pre-letting an off-the-plan build is that it may allow the occupier to have some influence over the build design, therefore creating a space tailored to their business’ needs. Businesses may also turn to pre-lets as they are typically cheaper to lease than an already existing property. Pre-lets sometimes include agreements for discounted or rent-free periods.

Tenants that tend to benefit from a pre-let are usually the larger, more influential businesses. These types of organisations generally have the ability to commit to a longer leasehold that a pre-let building requires. However if a tenant is already bound into an existing lease, the tenant cannot enter into a pre-let unless there is a break or expiry in the lease.

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The main focuses in construction methods

There are three main types of construction methods: the Traditional Method; the Design and Build; and the Construction Management Process. These methods all focus on different priorities. The traditional method allows the occupier to have some control over the design and specification. In this type of construction, the emphasis is usually on the quality of the finished result rather than the cost of the build.

The design and build method is when the plan is designed on the main requirements of the parties involved. This is usually the case when the build is formed on the cost rather than the quality.

The third method, the Construction Management Process, allows construction on the building to begin before the design of the building is complete. The main focus of this method is usually time over cost.

Potential benefits and risks to the occupier

Pre-lets hold many benefits for a potential tenant. As previously mentioned pre-lets usually allow tenants to pay lower rent and as a result, lead to better financial terms. Also, since the construction isn’t complete, the potential tenant can have a larger influence over the design of the building, making the space more suitable to their specific business.

For a tenant taking up a pre-let, a main risk is the potential that the building construction may not be completed on time. If a tenant’s current lease is nearing its expiry date, the uncertain timings of the incomplete building can be a major cause for concern. Another potential risk for occupiers could be the longer lease commitments that come with a pre-let building, as pre-let leases are often a minimum of 20 years. There is also the risk that the completed building will not live up to the occupier’s expectations.

Potential benefits and risks to the developer

One of the main benefits for a developer to enter into a pre-let agreement is to develop a strength of covenant and increase capital value. Furthermore the use of pre-letting a building before it is completed can also help to launch larger, more expensive projects. A pre-let arrangement may also support lenders requirements and ensure  finance is available for the build costs.

However there are a few draw backs when it comes to developers using pre-let agreements, with money being the main concern. As pre-let buildings are usually set at a lower rental rate than an existing building, the developer may end up losing profit. As a pre-let is an agreement entered into before the building is constructed, the developers will not be able to take advantage if the rental prices increase during the construction period.

The demand for office space in financially growing cities such as London and Manchester will surely see a significant rise in pre-let buildings. Pre lets are usually proven to be at their most popular when there is a surge in corporate occupiers. Although the pre-lets come with an amount of uncertainty, once entered into, they have many potential benefits for both the developer and the occupier.

 

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