LEASE-BASED PROJECT DEVELOPMENT - 6836

(New: 03/2025)

 

There are several project delivery methods that can be used by the state to construct capital assets:  Design-Bid-Build (Section 6828), Design-Build (Section 6829), and Lease-Based Development Agreements.  This section describes the process for pursuing a Lease-Based Development structure.

 

In general, when a new state-owned capital facility is proposed, the state’s preferred approach is to acquire property for the subject project. For this approach, an acquisition phase is funded through the annual budget process, and the appropriate department will engage with the Department of General Services (DGS) to search for suitable sites.  Once a property is acquired, future phases for the project will be funded through the budget process, and the project will be designed and constructed with DGS as the project manager, (or by the appropriate agency for non-DGS managed projects), with oversight by the PWB.  Government Code § 14669 authorizes the DGS to hire, lease, lease-purchase, or lease with the option to purchase any real or personal property for the use of any state agency, subject to specified restrictions.

 

However, in instances where the state is unable to identify and acquire a suitable site that supports a specific capital project, a lease-based development option may be considered. This type of lease structure is generally referred to as a Build-to-Suit Lease.  Under this lease structure, the state is not required to make any payments, including interim financing, until occupancy. 

 

Generally, there are two types of Build-to-Suit lease options the state may pursue: 

 

• Capitalized Lease Resulting in Ownership:   Sometimes referred to as an “in-substance purchase” or “Lease-Purchase”, a capitalized lease is one where the private sector is responsible for acquiring, developing, and constructing a facility that is built to state-issued specifications. The lease specifies that ownership of the facility transfers to the state at the end of the lease term. 
• Capitalized Lease with a Purchase Option:  Similar to a capitalized lease as defined above, but the lease gives the lessee the option to purchase the leased asset at a specified value at some point during or at the end of the lease period, sometimes referred to as a “Lease with Option to Purchase”.

Features of a Build-to-Suit Lease:

 

• The state, in collaboration with the developer, completes CEQA.
• The state is responsible for completing real estate due diligence activities. 
• A lease-based project is subject to the typical state design and construction oversight (e.g. Construction Inspections Management Branch of DGS, State Fire Marshal, etc.).
• The state’s sovereign status applies, and a lease-based project should not be subject to local zoning, permitting or inspection.
• Developer costs, and profits are folded into the lease payments. 
• Repair, maintenance and overall operating costs are generally folded into the lease until the lease expires.
• The terms of a capitalized lease should ensure the facility is in good repair at the end of the lease term, through the lease requirement for a Computerized Maintenance Management System.

Requirements for a Financing Lease:  As with lease-revenue bonds, the state’s debt obligations under the lease cannot be structured in a way which would classify them as constitutional debt.  The terms and conditions in the lease must be similar to the lease terms found in a commercial context for similar types of facilities. Features of a financing lease include:

 

• Rental payments are paid only for those periods in which beneficial use and occupancy of the leased property is available to the lessee.
• If there is no annual appropriation for rent when the leased property is available for use and occupancy, the state will be in default under the lease, and remedies may be available against the state.  These remedies may include the vendor’s or lessor’s right to continue the lease in existence and sue the state for each installment of rent as it becomes due. 
• Acceleration of rental payments is not permitted. 
• The obligation to pay rental payments may be from any lawfully available funds of the department. 
• The lease term should not extend beyond the anticipated useful life of the leased property, and fair market rental value should be paid.

Steps in a Build-to-Suit Lease:  After it has been determined that a project site is not available for a specified project, and that a lease structure should be pursued, the following steps must occur:

1. Statutory Authority:  The department submits a Capital Outlay Budget Change Proposal requesting Trailer Bill Language to add statutory authority to pursue a capital project through the capitalized lease structure pursuant to Government Code §14669.  Also, a future appropriation will be necessary to cover the costs of state oversight of construction activities.  For the year construction is expected to be completed, the department submits a Budget Change Proposal for one-time moving costs and rent.
   
   
2. Form 9 and 10:  After a project has statutory authority to enter into a capitalized lease, the client agency works with DGS real estate staff to create a Facilities Design Program that outlines project and program specifications.  The final outcome of this activity is memorialized through a Form 9 “Space Action Request” and Form 10 “Estimate of Occupancy Costs” submittal.  Both Forms 9 and 10 must be approved by Finance.
   
   
3. Solicitation for private development entity: DGS posts a “land ad” on the Cal eProcure website to determine the inventory of available sites in the desired project area owned by private developers.  A “short list” of potential sites is created, and the client agency ranks them based on desirability.   DGS will issue an RFP to developers on the short list.  Once a firm is selected, DGS will negotiate a lease contract that details the terms of the agreement, including a lease payment structure.
   
   
4. Legislative Notification:  DGS is required to notify the legislature prior to entering into a build-to-suit lease, pursuant to GC 13332.10.
   
   
5. PWB approval of Lease:  Although no capital expenditure is made when entering into a capitalized lease, a commitment to a capital acquisition is created.  Therefore, the final lease terms must be approved by the PWB prior to execution.  DGS must also present to PWB the real estate due diligence.  All requisite actions under CEQA must be completed within a reasonable time after PWB approval, as a “Condition Precedent” to the lease agreement.  If CEQA is not achieved, the state has the right to terminate the lease.
   
   
6. Design Development:  Once the final lease is approved, the development team will design the project to the state’s specifications, and will secure all required regulatory reviews and approvals, including those from the Department of State Architect and the State Fire Marshal (SFM).  In addition, the development team will work with local jurisdictions (City and County) to obtain any necessary approvals.
   
   
7. Facility Occupancy:   Once the facility is constructed, the SFM issues a Certificate of Occupancy, and the client agency approves and “accepts” the building for its use and occupancy.  The client agency makes annual payments based on the approved lease terms for the duration of the lease.  During the lease term, the developer is responsible for operating and maintaining the building.
   
   
8. Exercising a Purchase Option:  For leases with a purchase option, a capital outlay appropriation sufficient to fund the purchase of the capital asset and to cover any additional administrative costs will be required.  In addition, PWB’s authorization is necessary to exercise the purchase option.  However, the current standard is for build-to-suit leases to automatically transfer to the state at the end of the lease.