In a post-Brexit economy, reducing risk is a top priority for landowners and property developers. In a recent post, I concluded that all signs point to the property market softening over the next 18 months and London could suffer the most. The extent of how far the sector will fall depends on a number of factors, including; when Article 50 is triggered and how well exit negotiations go in Britain’s favour.
Nothing hinders investment and economic activity more than uncertainty. Which is why, following the shock vote to leave the EU, option agreements can benefit both developers and landowners as they provide a way for both parties to mitigate their exposure to risk in today’s shaky economic climate.
Option agreements – the essentials
Option agreements involve an agreement made between a landowner (the vendor in an option agreement) and a potential purchaser of their property. The parties draw up a contract which states that the potential buyer has a legally binding option to purchase the property at a certain date or within an agreed time-frame, or after completion of a certain event (for example after obtaining planning permission or required investment funds). In exchange for this right to buy, a sum of money is paid by the purchaser to the vendor. This money is non-refundable. The sale price is usually calculated according to a pre-arranged formula based on the market rate at the time of purchase or at a price fixed in advance.
Option agreements come in four varieties:
- Call option – here the buyer has the right to buy the property but is not legally required to exercise the right;
- Put option – the seller has the right, but is under no legal obligation to sell the property to the buyer;
- Cross option – the buyer receives a call option and the seller, in return, gains a put option;
- Reverse option – these are used to secure an overage payment (more on these below). The seller has an option to buy the property back after a certain event occurs which increases the value of the property (usually the acquisition of planning permission or development of it) if the overage payment does not materialise.
Using option agreements to mitigate risk for both parties
The main function of an option agreement is to mitigate risk. In today’s property market, this is gold. With no clear timeframe for how long Brexit negotiations could take and no clear picture on what the economy will look like following our official exit, developers, investors and landowners have little choice but to carry on with business as normal, or risk being in an indefinite holding-pattern and missing out on current opportunities.
Reducing risks for property developers
By entering into a call option agreement, developers buy themselves time. Time to secure planning permission, investment funds and placate any angry neighbours trying to up-end their development plans. They also secure a legal basis for the expenditure on planning applications, negotiations with other enforcement or regulatory authorities (e.g. the Environment Agency) as well as any highways and utilities undertakings that may be required for the project to proceed.
Without a call option, a developer is forced to spend thousands of pounds securing planning permission and negotiating with various authorities, which may all be for nothing if the land cannot be brought for a realistic price, or the owner refuses to sell.
Reducing risks for the landowner
With the market starting to soften, put option agreements allow property owners to achieve the increase in their land’s value via development without risking the substantial cost of obtaining planning permission. If a fixed price has been negotiated, then you will receive the price you desired, regardless of your property’s market value at the time of sale.
Adding to the advantage – landowners and overages
Property owners can not only mitigate their risk by entering into a put option, they can increase their profit upon sale by entering into an overage agreement with the buyer.
An overage or clawback is a seller’s right to recover additional payment(s) from a buyer at some point in the future, usually after completion of a sale. Usually this right is triggered by the occurrence of an event which increases the value of the land (e.g. the grant of planning permission or completion of development).
In most cases solicitors will draft a mechanism to protect your entitlement to overage. The most common methods are:
- legal charge;
- restriction on title;
- restrictive covenant;
- guarantee;
- ransom strip.
Overages are complex instruments and need to be drafted by an experienced solicitor. They should not be entered into lightly; sometimes simply increasing the purchase price will satisfy any desire to clawback the future increase in value. However, in a buyers’ market, which we seem to be heading into, this may not always be feasible in reality.
Concluding comments
The UK economy has entered a stage of inherent uncertainty. No one knows when Article 50 will be invoked and the consequences for the British Pound and the markets, not only during the exit negotiations which span two years, but after we officially leave the EU fold is unknown. In economically uncertain times, option agreements and overages are tools that come into their own. They allow both sellers and developers to carry on with utilising land to generate wealth, employment and investment, without risking their own financial stability.
In today’s market, that is a much needed positive for everyone.
Saracens Solicitors is a multi-service law firm based in London’s West End. We have a dedicated and highly experienced property law team who can assist you with option and overage agreements. For more information, please call our office on 020 3588 3500.
