What are a landowner’s options for strategic land development?
Vicky McDonald and Michael Higgin from our Commercial Property Team take a look at what choices landowners have when considering how their land could be used for development.
The government is currently tasked with delivering 200,000 new homes a year until 2020 – a stiff challenge based on past performance. Landowners with land suitable for development should consider the following main choices for how to approach the strategic development of their land.
This is a right which a landowner grants to a developer to ‘opt’ to buy the land from the landowner within a given period of time. In this context the developer generally agrees to apply for planning permission (which they do at their own cost and risk) and the option is in limbo until permission is granted. If the permission is deemed satisfactory, then the developer can ‘exercise its option’ to buy the land, at which point the landowner is contractually bound to sell to the developer, at the price which is agreed, or assessed by a third party if not agreed.
Usually that price is at a fair discount to its market value (and after deduction of the developer’s planning costs and the option fee and any costs it paid initially) to reward the developer for the risk it took in applying for planning permission at its own cost. developers like option agreements as they are able to gain priority rights to buy a piece of land ahead of their competition and without needing to pay the full price for it until such time as planning is obtained (negating any risk of purchasing, say, farmland which they have no use for as such). The developer nevertheless has the certainty that if they wish to do so, they can acquire the land.
The main advantage for a landowner is the benefit of having an independent third party bearing all of the risks and costs of obtaining planning permission, although an important disadvantage is the loss of control over the land. This is because the land is effectively ‘tied up’ for the duration of the option agreement (which could be 5 or 10 years – perhaps even longer, depending on the term negotiated) thereby preventing the landowner from freely selling the land to a third party.
A promotion agreement is similar to an option agreement, although here the landowner and the promoter (who will not necessarily be a developer) work together to ‘promote’ the land for development. In practical terms, this means the promoter taking steps to assess the suitability of the site, producing plans and liaising with the local authority to encourage the allocation of the land for development and then obtaining planning permission before then directing the landowner to sell the site to a third party. The costs of ‘promoting’ the land, and so the risk, are borne by the promoter in the first instance but are then repaid when the land is subsequently sold to a third party. How the remaining sale proceeds are split between the landowner and promoter is a point for negotiation but promoters will expect to receive a fair ‘cut’ of any sale proceeds as a reward for taking on the risk, which is largely equivalent to the discount awarded to an option buyer. As with options, a minimum land price is often stipulated
The key advantage to a landowner is that their interest is wholly aligned with the promoter to get the best price possible for the land, whereas a developer buying under option is keen to pay as low a price as possible. The landowner may wish to have a more active role in monitoring or assisting the promotion process, but has no obligation to do so and so need not risk its own funds in the process.
Promoters like promotion agreements as they do not need to buy the land themselves or carry out the development at the end, but can use their expertise to add value and earn a good promotion fee.
Landowners should be aware that they may be unable to sell the land during the term of the promotion agreement and should also be aware of any potential tax consequences which arise from the resulting ‘partnership’ which this agreement creates.
A hybrid agreement is, as the name suggests, an amalgamation of the above two agreements. They are most likely to be relevant on a particularly large site where a developer may be willing to build a set number of houses on part of the site and will have an option to buy at a discount to that extent, but will then promote the rest of the land (or indeed the whole, if it does not take up its option) for sale to third parties with the benefit of planning permission.
Generally speaking both promoters and developers will pay the landowner’s legal and property agents’ fees for dealing with the negotiation of terms and documents (although such costs are then usually paid back to them out of the sale proceeds/deductibles at the end) and so for most landowners they are largely free to enter into.
Promoters and developers will also often pay a fee up-front to the landowner for entering into the agreement – again this will be deducted at the end on any sale (whether to the developer or a third party) but if planning is not obtained then this is retained by the landowner.
It is common to provide a minimum land price to be achieved for the landowner “per net developable acre”, which figure depends on the state of the market and the location of the land, as a safety net value, below which they need not sell. If this happens deals can be put on ice for a period of time (2 years is not unusual) until the market recovers – a so-called “freezer clause”. Promotion Agreements will often also provide for a minimum return for the promoter, below which the marketing period can be similarly extended, or a choice for either party to sacrifice its target profits in order to secure a deal.
Deductible costs are often capped. This prevents costs eating away profits to the detriment of the landowner, and gives a trigger at which the developer/promoter can walk away if the costs of proceeding are outweighing the potential profits.
The Commercial Property team has a wealth of experience in dealing with the above transactions and has acted for a number of landowners as well as developers and promoters, often with large national house-builders/developers involved. We have excellent connections with agents and promoters who operate in this field. So if you are a landowner, or know a landowner who is interested in exploiting the opportunities available for the development of their land then please contact Michael Higgin or Vicky McDonald in the Commercial Property team.