When selling a property, it is important not only to consider the current value of the property, but the potential for the property to increase in value after it has been sold. This is commonly the case where it is likely that the property may be developed in future (for example, for housing, or for commercial development).
Selling parties are often interested to know how they can use overage agreements to get the most out of their sale by realising the development potential in the property they are selling.
Simply, overage (sometimes used interchangeably with ‘clawback’) means a surplus of money beyond a given estimate. It follows that, in a property sale, an overage agreement is where the seller will be paid a surplus should a specific event happen in the future.
Overage agreements are usually entered into where land that has development potential is sold. For example, an overage agreement might provide that overage needs to be paid if the value of the land increases as a result of planning permission being granted for development or if planning consent is obtained for a development larger than originally anticipated (planning overage). Alternatively, an overage agreement might require a developer to pay the original seller a share of profits arising from plots that it sells (sales overage). Sometimes parties enter into hybrid arrangements.
It is important to consider what events should actually “trigger” an overage payment.
Usually, overage will be payable on the happening of specified “trigger events”, often within a certain period of time. For example, when construction starts on a development, or when land is sold on with the benefit of planning permission (thus being sold at a higher value than the seller originally sold it for). An effective trigger mechanism will need to be included in the overage agreement, and the trigger will vary depending on the exact scenario.
Some overage arrangements will terminate after a single overage payment is made, whereas others will provide for sums to be paid multiple times, on the recurrence of a certain event happening (for example, where multiple plots are sold at the same site).
Selling parties should exercise caution in deciding when overage will become payable, given the unpredictable nature of property development. These are often matters of some negotiation in property sales, and it is always best to seek expert advice.
When calculating how much overage should be paid to a seller, it is important not to overly-complicate things. A simple mathematical formula is usually used which often deducts the base value of the property from the enhanced value, with account being made for certain allowable deductions.
Calculations will start to look a little more complex when it comes to overage payable on larger developments. Including worked examples of the overage calculation in the agreement can be a helpful way to show how the calculation should work. Ultimately, the amount of overage that should be paid will depend on the circumstances in question, and careful attention should be paid when documenting the calculation.
Careful consideration should always be given as to whether overage is appropriate to the transaction in question. Overage arrangements can be complex and the legal fees for negotiating overage arrangements can be significant. It should not be seen as a substitute for deferring an element of the consideration but rather as the ‘icing on the cake’ should a trigger event occur.
If you have any questions concerning overage payments, or you are considering a sale of land subject to overage, please get in contact with a member of our Transactional Real Estate Team.