A forward funding development agreement (also known as A Development Finance Agreement) is established when the financier of a building’s construction offers interim funds to enable development. It allows investors to obtain a fixed rate of return on their investments.
Upon completion, the buyer makes a final balance payment on the property’s value, from which any previous payments are removed.
Stamp Duty Land Tax is only imposed on the value of the vacant property site, and not on the value of the land with improvements, resulting in a reduced tax obligation compared to a typical transaction. In this article, forward funding development agreement, we take a look at the process involved and the options available to you.
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How does a Forward funding development agreement work?
In a forward funding development agreement, as opposed to a forward purchase agreement, the purchaser/fund provides funds to cover all costs of the development as it progresses (such as invoices from building contractors, architect’s fees, etc.).
Under this arrangement, the developer may accept a smaller profit (but a lower risk) than if it had created the property with its own funds and then sold it as an investment. The fund assumes considerable risk but expects a cheaper purchase price and a greater yield than if it had waited until the development was finished and leased before committing to buy it.
In a typical forward financing deal, the developer promptly transfers the freehold to the fund (who are then reassured that they are advancing money to be spent enhancing their own land).
Additionally, the developer may withdraw monies from the fund to meet construction costs. Typically, the fund pays monthly invoices for expenses up to an agreed-upon maximum commitment. In addition to being responsible for any expenses above the maximum commitment, the developer commits to construct the development in a particular manner.
When the lease is granted, the fund generates a profit for the developer.
What are the risks associated with forward funding for purchasers?
Buyers must beware of forward sales that look like forward funding agreements. A forward sale is a valid transaction structure, but it lacks the tax advantages of a forward funding agreement. An expert real estate solicitor will be able to assist you in determining if a forward funding agreement is the most suitable and advantageous form for your transaction.
It is essential to have contingency measures in place, as some forward funding arrangements run into trouble when developers default on their commitments.
What are the risks associated with forward funding for developers?
For developers, the primary downside of forward funding agreements may be that the final price is fixed, but the interest rates and development costs can fluctuate throughout the project. As a result, developers can incur losses if the pre-transaction payment does not cover the total cost of the development.
How is the developers’ profit calculated under a forward funding development agreement?
After the development has been constructed and leased, the developer is paid a profit. Typically, this is determined by:
- Calculating the value of the completed development (often by capitalising the total rent roll based on agreed-upon assumptions such as yield and handling of unexpired rent-free periods).
- Deducting the overall development costs (including capitalised interest from this amount).
Occasionally, the method will subtract the development costs from a fixed amount rather than the value of the final development.
What construction documents are required?
Forward funding development agreements cover the relationships between landowners, developers, funds, tenants and banks. Whenever a development is constructed, there will also be detailed construction documents regulating the separate relationships between these parties and the building contractor and other professional consultants. This will include building contracts, professional appointments and collateral warranties/third party rights.
How we can help
We have a proven track-record of drafting development agreements. Not only does our construction department have extensive legal experience and knowledge of construction law but we also have the benefit of chartered surveying experts. We will guide you through the process and ensure all checks are carried out swiftly and efficiently and we firmly believe that with the right solicitors by your side, the entire process will seem more manageable and far less daunting.
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How to Contact Our Construction Solicitors
It is important for you to be well informed about the issues and possible implications of a development agreement. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
To speak to our Construction solicitors today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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