Built-to-Suit Leases in Brazil: A Tailored Solution for Real Estate

Real estate is a great investment in Brazil. We have large parcels of land spread in the country and potential for growth in diversified industries. And although our first thought when a company is coming to the country or is expanding its business here is that they will buy land, over the last two decades, we have seen a surge in companies entering built to suit (BTS) lease contracts. Companies are using this contract especially among industrial and commercial businesses, for warehouses, distribution centers, data centers, and even hospitals.

Several factors contribute to this growth. For starters, BTS leases allow businesses to expand without major upfront capital investments since they avoid purchasing property. Plus, the tenant does not bear the construction risks and can obtain tax benefits specific to this arrangement, and the landlord has assured tenancy for a long time. The rise of e-commerce has also fueled the demand for BTS leases, as companies need more space for logistics of products and warehousing. And while relatively new to Brazil, the BTS concept has been around in the United States since the 1950s. Fun fact: instead of the original term “build to suit”, in Brazil the term has become popular as “built to suit”, having the same meaning.

The BTS is a customized lease agreement: the landlord agrees to build or renovate a property to meet the tenant’s specific needs and design. Unlike a common lease where the contract serves simply for the assignment of use over a certain space, BTS centers around the construction or renovation of a space tailored to a specific tenant, which may even include using the tenant’s branding in the interior design of the facility, and, after construction is concluded, the lease of such facility for a longer term.

It is different from ground leases, too. In a BTS arrangement, the tenant does not take on construction or renovation responsibilities. The landlord acts as both lessor and developer, undertaking the obligation to build or renovate, and besides being liable for the construction upon the tenant, the landlord can hire a contractor for the construction. Another key difference is that at the end of a ground lease, the landlord typically compensates the tenant for improvements. In BTS, however, those improvements become part of the property and remain with the landlord when the lease ends.

With a BTS lease, the tenant’s monthly payments do not compensate the landlord only for the use of the property, as it happens in a common lease. The rents also cover the construction costs borne by the landlord, who gets the reassurance of a long-term return on their investment.

From a legal perspective, the Real Estate Financing System was created in Brazil in 1997, allowing construction companies, developers, and real estate financing institutions to access the capital market, through the commercialization of real estate related securities. Given that BTS agreements generate a steady cash flow, the rental income serves as real estate collateral and, as a result, the market has started to use it to issue a security called Certificate of Real Estate Receivables (CRIs). And, despite the differences between this contract and common leases, the Brazilian Lease Act only changed in 2012 to expressly recognize the use of this modality and validate the inapplicability of certain provisions related to common leases for BTS leases.

Back to the business perspective, for tenants, BTS leases mean the ability to define a project’s specifications, customize the space, and avoid tying up capital in property acquisition. They can also benefit from tax deductions on corporate income tax and social contribution on net profit, as rental payments qualify as operational expenses.

For landlords, BTS leases represent an investment opportunity with a built-in client. Demand precedes supply in this type of investment. There is an assured tenancy, the landlord is not in risk to be stuck with a vacant property, unlike it may occur in a common lease, since landlord and tenant must sign the contract before construction begins. Plus, Brazilian law allows landlords to require double guaranties from the tenant - such as security deposit, surety bonds, guarantors -, providing a greater protection for the continuous flow of rent payments. For common leases, however, Brazilian law prohibits requiring more than one form of guaranty.

Another key aspect of BTS leases is the penalty for early termination by the tenant and the judicial review of the rent. In common leases, Brazilian law stipulates that the calculation of the agreed-upon penalty (usually 3 to 5 months’ rent) will be proportional to the fulfilled term of the contract. This means the longer the contract has been in effect, the lower the penalty paid by the tenant. However, because BTS leases aim for long-term relationships and rentals compensate the landlord’s investment, early termination carries heavier consequences. Legislation allows for penalties equivalent to the total rent due until the end of the contract. Even if the tenant fulfills half the lease, they may still owe the full amount of the remaining rent.

For common leases, Brazilian law allows either party to request a judicial review of the rent amount after 3 years, adjusting it to market prices. In BTS leases, however, parties can waive the right to judicial review since the rent is also meant to compensate the landlord’s investments.

As you can see, BTS leases offer significant benefits to both landlords and tenants. However, this is a complex contract, and negotiations must be meticulous to avoid unintended consequences such as delay in the operations or application of high penalties. Tenants need to carefully review construction timelines, especially considering the impact of their operations and obligations assumed by them with third parties, like suppliers. In addition, a thorough technical and legal analysis can ensure the property is suitable for tenants’ activities and that they will not face issues obtaining or renewing licenses.

Landlords, on the other hand, must ensure the guaranties offered by the tenant are sufficient to maintain the expected cash flow, especially if they plan to assign the lease receivables. In securitization transactions, the landowner usually gives the property in fiduciary sale (a type of collateral in Brazil in which foreclosure in case of default happens outside of courts, similar to the power of sale clause in mortgages in the United States) to secure the payments owed to the securitization company. Default could result in loss of ownership over the property. Also, BTS agreements can be part of broader structured transactions where the terms of the BTS lease impact the entire deal.

BTS leases are long-term, relatively new in Brazil and most disputes arising out of such contracts are resolved in arbitration, and thus, are confidential. Although there is not extensive case law in courts, we can see a mix of decisions recognizing the terms of the contracts and some decisions providing for the review of part of the contract, which is seen as a remedy applied in exceptional situations. Because of that, clear and precise drafting of the contract terms is essential to demonstrate the parties’ intent and balance their obligations. Built-to-suit leases are a powerful tool for installation or expansion of companies in Brazil, offering tailored solutions for businesses and investment opportunities for landlords, however, their complexity requires careful navigation and expert legal guidance.