The success of an option agreement hinges on effective negotiation with the developer, while landowners can also look at the alternative of a promotion agreement. Julie Liddle examines the pros and cons.
This is a complex area of work but very briefly, an option agreement is a cost-effective way for landowners to increase the value of their land without getting directly involved in the planning process.
The risk is taken by the developer – or option holder – whose aim is to enhance the market value, from which both parties receive a percentage. The percentage received by each party is a key element of the negotiation that must take place at the outset but will undoubtedly reflect the costs the developer has withstood in order to get planning approval.
Before reaching this stage, though, landowners should take into consideration the main downside of an option agreement, which is their loss of control over the land as the landowner is unlikely to be able to sell the land to a third party for the duration of the option agreement, which can be anything from five to 10 years – and sometimes longer.
Professional negotiation is crucial to a successful agreement
A thorough negotiation, using professional advisers, is the bedrock of an effective option agreement and will ultimately determine the success or otherwise of the venture.
The negotiation is not simple and should involve a detailed and comprehensive discussion of the value of the completed development. As part of this, the developer’s estimated costs and profit should be ascertained in order to evaluate the market value.
The negotiating remit should also include analysis of local market conditions and similar land transactions. In this way, a fair purchase price can be agreed.
What happens if a price cannot be negotiated
The option agreement should contain provisions for dispute resolution for situations where both parties cannot agree the purchase price at the time planning permission is received.
Dispute resolution typically requires the appointment of an independent expert, who is also a qualified chartered surveyor. The landowner and option holder can agree who this person should be, or have one appointed by the Royal Institute of Chartered Surveyors (RICS).
Written submissions setting out market-based evidence and appraisals are usually employed by both the landowner and option holder to support their assessment of value.
After hearing from both sides, the expert will decide a purchase price and the option holder can decide whether or not to purchase the site at this price. Notice, that most options are ‘take’ options where the developer decides whether or not they wish to purchase the land usually at the time a successful planning permission has been obtained.
The advantages of a promotion agreement
A promotion agreement is a popular alternative to an option agreement. There are many similarities, although a promotion agreement involves the landowner and promoter (who is not always a developer) working together to promote the land as a development site.
This usually means the promoter evaluating the viability of the site, bringing forward plans, and talking to the local authority with a view to getting the site allocated as development land. Next, the promoter will obtain planning consent and eventually work with the landowner to sell the site to a third party.
The costs of promoting the land – including the risk – are initially carried by the promoter, although recovered when the land is sold.
The division of the sale proceeds between the landowner and promoter is decided during the negotiation. However, promoters expect a fair percentage of any sale proceeds as a reward for taking the risk. This is broadly similar to the discount awarded to an option buyer. A minimum land price is often specified in the original agreement.
Main differences between promotion and option agreements
The key advantage of a promotion agreement to a landowner is that your interests are entirely aligned with the promoter’s because you both want to obtain the best possible price for the land.
In contrast, a developer involved in an option agreement will naturally want to pay the lowest price possible to the landowner.
In addition, as a landowner you can get more actively involved in the promotion process if you wish, but there is no obligation, which means you do not have to risk your own funds.
Finally it is important to consider that landowners might not be able to sell the land during the term of the promotion agreement, in much the same way as with an option agreement.