The construction lease: a solution to address land scarcity?

It is no secret: logistics real estate needs land to grow. Nor is it a secret that land available for this activity is becoming increasingly scarce. Between elected officials’ decisions, which are rarely favorable to logistics, and ZAN (Net Zero Land Take), finding land for logistics and industrial use is a daunting challenge. What can be done? A construction lease may offer a solution. Governed by Articles L. 251-1 et seq. of the French Construction and Housing Code, the construction lease has existed since the Act of December 16, 1964, and was modernized in early 2007 when the Pass-foncier scheme came into force. It enables owners to make their land available for companies to construct buildings on it without relinquishing ownership. “In fact, it separates ownership of the land from ownership of the building,” explains Fabien Guisseau, Deputy Director General for Economic Development and Strategic Partnerships at Grand Paris Aménagement (GPA), which recently created Terra Eco with Banque des Territoires, the first land company dedicated to managing construction leases. “This agreement enables developer-owners to make their land available while retaining control over its future uses. Elected officials want to be able to make choices over the long term, rather than only concerning the initial use, in order to address potential changes in competition among uses.”

For land tenants, who also hold a real property right in their construction—meaning they have the right to mortgage it freely, potentially securing a loan, transfer it freely, and grant certain easements—“the benefit is finding land that, moreover, within a ZAC, has already been prepared to accommodate logistics or industrial activity,” notes Christophe Ripert, Deputy Chief Executive Officer for Urban Logistics at Quartus Logistique. “Our activities are also more readily accepted, since the land was already intended for this purpose. In addition, many studies have already been conducted, allowing us to save valuable time.” Unlike other leases, such as a long-term ground lease, a construction lease requires the tenant to erect a building and/or undertake renovations and improvements on the landlord’s land, including demolition followed by reconstruction. Upon expiry, the construction lease, which can run from 18 to 99 years, grants the landlord ownership of the structures built by the tenant. The landlord may also require the tenant to demolish the building and remediate the land.

While a construction lease offers a number of advantages to both parties—the landowner can generate revenue from property that is sometimes unused pending future development, and the tenant can obtain land to build on without having to purchase it—it is important to note several points of caution. “The building constructed and maintained by the land tenant must be returned to the landowner or demolished so that the land is restored to its original condition,” explains Christophe Ripert. “In either case, this represents a loss of value for the developer, which must be factored into its business plan.” In his view, a construction lease offers no economic gain. “A rent is paid throughout the lease term, revised every three years (indexing example: ILAT), and at expiry, no residual value remains, either in the land or in the building.” In a development transaction, the future investor will account for this loss in value by increasing the capitalization rate by 75 to 100 basis points. Fabien Guisseau acknowledges this argument. “Certainly, the investor pays rent for land it cannot buy. But this preserves its cash, and once the construction has been depreciated, it earns net income from leasing its building that is more favorable for tax purposes because of the construction lease. The key to the return balance then lies in the term granted. Beyond 50 years, the economic benefit is real.” He also believes that this type of agreement curbs land speculation and therefore helps limit rising land prices, even as land becomes increasingly scarce.

Rarely used in France to date because of cultural factors, the construction lease may be seen as a loss of control for the tenant, which will have invested in its building both financially and psychologically, since it must hand it over to its landlord upon expiry of the agreement, “unless the agreement is revised on the basis of a new project that arises in the meantime,” comments Fabien Guisseau. “Which remains highly likely, given the duration!” Developers and investors still rarely make public statements on construction leases. “Yet examples have multiplied over the past two or three years, and some local authorities are systematically introducing this type of lease,” he adds. “Everyone is becoming acutely aware of the wall of land scarcity.” The long-term commitment, the obligation to build, and the complexity of the business plan created by an agreement with which logistics real estate players are still unfamiliar require an in-depth feasibility study and careful consideration by both landlord and tenant.