What Is a Forward Fund?
Updated: Oct 2
A forward fund is where an investor acquires a development site and pays for the building to be constructed, in stages, as the work progresses. The business that will occupy it agrees the lease terms up front, moves in on completion, and pays rent — without having funded the construction itself.
The core benefit: a business gets a purpose-built facility specified to its own requirements, without the capital outlay of developing it or the debt needed to fund construction.
Common situations where this is used include: a business outgrowing existing premises, consolidating multiple sites, or needing a facility with specifications that don't exist in the available market.
There are two main starting points for these deals:
1. Where a business already owns the land (it maybe adjacent to an existing facility)
2. The need has been identified but the location has not
Both scenarios ultimately lead to the same destination: an investor coming in to own and fund a new building in return for your business agreeing a long lease.
In scenario 1, the ownership of the land allows for a more bespoke delivery – you may have a preferred contractor who understands your business and you are just bringing in capital to turn short term capex into a long term lease liability. Conversely, you may select an investor/developer who will deliver the whole project to an agreed specification for you to occupy and pay rent on completion of the project.
With scenario 2, there tends to be less flexibility for the business to dictate terms unless there are significant land options available to choose from. If the land is controlled by 3rd parties then they are more likely to dictate the terms of development.
What is an investor looking for?
Managed risk - whilst a funder can be brought into an existing project to provide capital, it does require the construction contracts and specification of the building to be ‘institutional’, i.e. drawn up in such a way that does not unduly expose them to construction risk.
Cost coverage - because rent is not paid until occupation (or however, the contract is structured), interest incurred during the construction phase is rolled up into the total capital and is seen as a cost of funding.
When looking at how much can be raised, a development appraisal is undertaken which looks at:
Cost of land and associated fees
Construction cost and contingencies
Finance cost
What the completed scheme would be worth
A profit tailored to the risk profile of the scheme
An investor will only fund a scheme which matches their risk profile. Understanding who the investors are who will be comfortable with different risks is a key to getting your scheme delivered.
What the business gets and gives up
Gets:
a building specified to its own operational requirements
no construction funding requirement
no development debt on the balance sheet
cost certainty agreed before work starts
Gives up:
ownership of the completed asset and any future appreciation in its value,
a long-term lease commitment agreed before the building physically exists.
What are the alternatives?
Self funding
self-development retains ownership and any development profit, but requires capital, debt, and carries construction risk directly. This may not be where your businesses expertise sits
Forward commitment
A forward commitment is more akin to a self fund than a forward fund. Essentially you agree in advance a lease and a sale price with an investor then self-deliver the project taking the same risks as self funding
Leasing an existing building
Development generally occurs where the building that you want is not available to lease in the market and the only way to have it is via new build. Taking existing stock is usually the quickest way of taking occupation but it is clearly constrained to what is available
What this means
If a new building requirement has been identified, it is likely to be competing for capital with other projects internally. And the nature of property is that it tends to be very capital hungry. By exploring the opportunities around forward funds, businesses have the ability to spread this cost over a much longer time horizon – one that far better matches the time you will operate from the facility for.
Another consideration is understanding what an investor will fund. There are broadly three buckets of spend:
Shell and core – the finished structure of the building including lifts, dock levellers etc.
Cat A – carpets, general HVAC etc
Cat B – tenant specific fit out, e.g. branding, chairs, desks, specialist equipment, racking
A funder is usually happy to fund Shell and Core and part of Cat A (a contribution is usually negotiated) whilst Cat B is the tenant’s cost. There are funding models for Investment Grade tenants where Cat B can be funded via an increased rent payment. Whilst there is typically inherent value in the Shell and Core, Cat A and particularly Cat B will like depreciate at a faster rate than the structure and this will be reflected in how an investor prices their funding.
The final word
Care needs to be taken to ensure that risk sits with the appropriate party and that the funding structure reflects this. It can give businesses an opportunity to bring in construction and development expertise into projects to help deliver them quicker and within budget.
