Selling land for development – Getting the deal structure right

There are various deal structures that may be used when selling land with development potential. Which structure best suits the transaction may be driven by a number of factors and ultimately comes down to the degree of risk, control and flexibility required by the parties. We provide a summary of the main deal structures below. Each has its merits and landowners may wish to remain flexible to attract a greater level of interest following which terms can be compared.

Option Agreement

The landowner offloads the risk and the developer seeks to secure a satisfactory planning consent for development within a specified period of time, taking on the associated costs. In return, the Developer has the exclusive right to purchase the land once planning is secured either at a pre-agreed fixed price or at a discounted sale price, usually a percentage of open market value between 75%-90% depending on the degree of risk and return. The costs of promoting the land and securing planning are usually deductible from the land value, however, these are often capped at an agreed amount to give the landowner more certainty. An upfront option premium may also be paid by the developer to the landowner.

An option is a binding agreement and, if not exercised by the developer, will come to an end. They are generally preferred by developers to other strategic land sale structures and more common where sites are likely to take longer than two or three years to achieve planning consent. A conflict of interest between the landowner and developer may arise when negotiating the ultimate sale price which is not tested on the open market (unlike a promotion agreement). To protect the landowner’s position a minimum price return and a cap on costs may be included.

Promotion Agreement

The landowner enters into an agreement with a specialist promoter and, similar to an option agreement, the promoter uses reasonable endeavours to obtain planning consent for development at its own risk and cost. The difference from an option is that when consent is secured the land is sold in the open market (rather than to the promoter) and the promoter shares in the net sale proceeds after planning costs have been deducted and reimbursed to the promoter. The promotor typically receives a promotion fee on the sale of 10-25% sale price after deductions.

Promotion agreements are often preferred by landowners as the sale price is market tested and the open market value may be higher in the open market without being restricted by assumptions in calculating market value included in an option which may be disputed. The Promoter will make a profit without having to finance the acquisition or development and its interests remain broadly aligned with the landowner’s interests throughout the process.

Hybrid Agreement

Hybrid agreements offer a blended approach. The landowner grants the developer an option with the ability to elect to sell the land or parts of the land to a third party and share the sale proceeds with the landowner. Similar to a standard option, the Developer may acquire part of the site on securing planning consent for a discount of market value, however, a hybrid agreement may require the remainder of the site to be marketed and sold to the highest open market bidder, akin to a promotion agreement. The sale price for the part that is sold on the open market may then be used as the basis for calculating ‘market value’ in the option element of the agreement. This avoids the price being determined on the basis of an RICS Red Book valuation, which may result in a lower land value as mentioned above.

A hybrid agreement is often most suitable for larger sites where there is sufficient land to be sold in phases. The advantage to the landowner with the hybrid structure is removal of the conflict of interest in agreeing the sale price. A complexity that can arise is over who builds the initial roads and services where the land is being sold in phases.

Conditional Contract

A conditional contract is a binding agreement on pre-agreed terms. Unlike an option or promotion agreement, the terms are identified and agreed at the outset. This usually includes the price, extent of development and the parameters for fulfilling any condition. The parties must proceed with the sale and purchase on these agreed terms once the condition is satisfied and within the stated timescales.

In relation to the sale of land for development, the condition would usually be the buyer obtaining a satisfactory planning permission. The buyer must use reasonable endeavours to procure satisfaction of the condition within the specified timescale. Once satisfied, the contract becomes unconditional and the sale completes. If the condition is not satisfied by the stated date, then the contract will terminate.

A contract conditional on planning is usually more suited to sites which are allocated in the relevant local plan for development, or where there is already outline planning permission and it is agreed that the contract shall be conditional on the grant of a reserved matters consent. They may not be appropriate where there are other uncertainties in addition to planning.

Unconditional Contract with Overage

Another option on selling development land may be to agree an unconditional sale, with or without full planning consent, for an agreed price but retaining the right to receive a further payment should planning/further planning consent be secured or the site be developed more than an agreed threshold. This clawback of future value can be agreed by way of an overage agreement. The additional sum of money payable to the seller landowner may be triggered on achieving planning permission, a change of use, development of an additional area or additional dwellings, or the sale of dwellings at a price which exceeds an agreed threshold.

The benefit of this arrangement for the landowner is the immediate receipt of capital monies, however, the overage payment is entirely contingent on future events outside the control of the landowner and is therefore at risk. The risk associated with the overage payment may be reflected in the commercial terms of the overage that are negotiated.

Best fit

Landowners are often advised that a promotion agreement would be in their best interests and realise the greatest land value, mainly due to the sale price being market tested. A developer may, however, offer very competitive terms for an option agreement where it wants to build out the site. Ultimately which structure is the best fit will depend on the circumstances and terms offered and landowners are well advised to consult an agent and solicitor with experience in this complex area in order to plan early.