Property Development | The Secrets to Safeguarding Your Investment
Property development….the words conjure up ideas of multi-million pound profits, high-rolling lifestyles and smart, savvy people who can envisage a stunning office block emerging from a derelict row of terrace houses. Whilst the potential returns can be healthy, the risks of such investment are not for the faint of heart. To safeguard your investment you need sound, solid advice to ensure the necessary precautions are taken.
Over the coming weeks and months we will be posting a series of articles detailing the considerations one should have when embarking on a property development venture. They are aimed at those with limited experience but intent on breaking into the sector and partnering up with a builder or construction company to achieve their objective.
This particular article is a general overview and should be read in conjunction with the others to ensure the reader attains a more detailed insight.
To start, the investor must consider the following keys to success:
Ensure you have properly drafted heads of terms
When the main terms have been agreed, it is essential to have them detailed in a document. This is commonly referred to as the HoTs, the heads of terms document or the agreement in principle. A heads of terms document details the main commercial points of the transaction, covering everything that is essential to the deal. Make the document as clear and complete as possible. Vague, ambiguous intentions from the outset can lead to many questions and result in more time being needed to negotiate the deal causing greater legal costs. Generally the document is a précis of the main agreed points and whilst it should not be seen as the contractual tie between the parties, certain aspects should be legally binding. For example if one party is to pay the costs of the other or if there are cross border / jurisdiction issues (due to tax planning or because of the origins of the parties) you may want to impose a governing law provision in the event there is a breakdown in relations and a dispute arises. It goes without saying, engaging your lawyer from the outset can save you a lot of time and money.
Ensure your heads of terms document states that it is subject to contract to ensure you are not legally bound by the terms featured (unless specifically stated otherwise) and do make specific mention of contingencies, for example if completion is dependant on obtaining planning permission.
Select the best business structure for your particular deal or property
Choosing the right business set up for your venture is vital to ensure you can raise capital for your investment and ensure effective tax planning. There are various forms you may adopt including:
- Limited liability companies
- Limited or limited liability partnerships
- Trust(s) of land
- UK Real Estate Investment Trusts
The most common approach is to establish a joint-venture company and agreeing an arrangement with a developer. A joint venture is an association of two or more individuals or companies, similar to a partnership, but with one key difference; a joint venture is set up for a single business transaction rather than an ongoing, long-term business relationship. It allows the investors and developer to operate under one legal entity when it comes to purchasing and selling the land, submitting planning permission and entering into contracts with sub-contractors.
If you decide to opt in to a joint venture agreement you will need to ensure you have a detailed shareholders agreement to protect each investor’s interest. The agreement should contain information pertaining to profit sharing, voting rights, disputes resolution, managing deadlocks, and clauses protecting the competitive interests of the company. If you are investing the majority of the money, it is wise to minimise your risk by including preferential clauses. For example, you may wish to have a clause allowing you to withdraw your money from the company before any other shareholders (this may save some if not all of your invested money in the event of insolvency).
Think about tax. How you structure your affairs can make a difference when it comes to the amount of tax you will pay. The ultimate aim of course, is to make money but wherever there is a gain, comes with it, a potential tax liability. For example, if the property is held in partnership and it is treated as an investment for tax purposes, the profit is treated as a capital gain rather than trading gain and is subsequently taxed at a lower rate for UK tax-resident shareholders. If the property is held in a company the advantages are less for the investor. You may also be eligible for entrepreneurs’ relief, which means you will only pay 10% capital gains tax on any qualifying profits.
Spend time ensuring the development agreement is correct
The development agreement governs the relationship between the land owner (for example the joint venture company) and the developer. It is vital for the success of the venture that this is drafted to take into account the following provisions:
- Obtaining planning permission(s)
- Details aspects regarding the profits and costs of the project
- Has provision for a valuation to be undertaken by a registered surveyor to ensure projected profits are realistic
- Deals with insurance
- Details a full compliment of warranties to cover the quality of the building design
- Deals with time extensions with regards to completion of the project
- Focuses on any Section 106 considerations regarding social housing and indeed any CIL liability
- Also deals with any compensation payable due to major delays or non-completion of the project
Don’t risk your project becoming a horror story due to lacking due diligence!
Due diligence is the process of factual and legal investigation, research, analysis and discovery into the relevant parties, the asset, project itself and other principal issues typically undertaken by a prospective buyer or investor prior to entering into a transaction. Make sure the development project and the land itself is fit for purpose before you commit yourself and your money to the venture by conducting thorough and proper due diligence analysis and certainly before you negotiate the development agreement.
Consider an Option agreement to maximise your profits
After investing in the project you may want to purchase the completed development for investment purposes or to enhance your profits. In this circumstance, an option agreement would be agreed with the owner of the property (i.e. the joint venture company or partnership) guaranteeing you the right to buy the property / development at, or within, a certain period of time, for a pre agreed price – usually in exchange for a non-refundable sum of money. The advantage of doing so enables you the first right of refusal during the agreed period and also allows you to pre agree a price. Speculators may wish to take a punt on the final sale value of the development (commonly known as the GDV or gross development value) and in an increasingly buoyant market, may in fact crystallise a sale price early taking advantage of the market, thereby maximising profits.
If an Option agreement is put in place, it should be registered against the title of the land as a form of security and during the option period, the owner of the option right may serve notice to exercise its rights.
Include the property / development sale contract within the option agreement itself. Have the sale contract negotiated at the same time and ensure it is added as an appendix to the option agreement. This will protect your interests and avoid a dispute on the terms of the sale if the developer seeks to refuse the sale or becomes difficult at that stage. The idea is to agree the option agreement so when exercised, the process is more procedural as opposed having to face a secondary round of negotiations.
All in all, this article serves as an introductory (high level) guide to property development. It goes without saying expert advice should always be taken before embarking on commercial projects but nonetheless, we hope you find these points useful.
Property development is notoriously risky. Don’t take chances; the costs and returns involved can be very high whilst the risks can bring about serious issues. Spend the necessary time and money at the start of the venture to ensure there are no surprises or disputes in the long run and your venture will have a better chance of success.