Option agreements are entered into between landowners and developers with the intention of granting the developer an option to purchase the land by exercising the right at any time during an agreed ‘option period’ in return for an ‘option fee’. Option agreements are used where a developer is interested in purchasing the land for residential and/or commercial development and the developer would ordinarily use the option period to apply for and secure the necessary planning permissions required to proceed with their development. The right to exercise the option will lie with the developer. In this article, what is an option agreement, we take a look at the mechanism and process involved.
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What are the advantages for the landowner?
The landowner can demand payment of an option fee from the developer in exchange for the right to exercise the option. This fee would be retained by the landowner whether or not the option is actually exercised. The option fee is an additional sum to the purchase price payable for the land when the option is subsequently exercised.
The developer will apply for planning permission at their own cost and risk. This allows landowners to promote their land for development without having to go through the lengthy and costly process of obtaining planning permission themselves. Landowners can take advantage of the experience and skills that developers have when it comes to obtaining planning permission.
Once the land has been developed, it will have an increased market value and so landowners may also want to think about mechanisms by which they may share in the developer’s profits or uplift in the value of their land even after they have parted ways. This is known as an overage agreement.
What are the disadvantages for the landowner?
It should be remembered that entering into an option agreement does not necessarily guarantee a sale at the end of the option period. This could be considered risky for the landowner as they will be entering into an agreement for what is often a lengthy period of time, restricting the landowner from selling the property to any other interested party without the guarantee of a sale at the end of the option period.
If the developer fails to obtain the required planning permission needed to develop the land, the developer is unlikely to exercise the option and the sale of the land would not therefore proceed. Option agreements allow developers to consider the possibility of acquiring land for potential development without being obliged to do so and gives the developer the security that if they spend significant amounts on obtaining planning permission, they can buy the land and not lose their financial investment. An option agreement also allows a developer to lock out others from buying the land for a defined period of time. Consideration should therefore be given to the option period and option fee amongst other matters to mitigate against such risks.
A well drafted option agreement can be a practical method by which landowners can offer up their land for development and reap the rewards of doing so, without having to be directly involved in either the planning or the build.
Establishing the land purchase price
The terms of an option agreement normally relate to planning, with the agreement allowing time for a site to be promoted through the planning process and for relevant planning permission to then be obtained. Once this happens, a Price Notice is normally served to the landowner, which then triggers the price negotiation process and the purchase of the site through an Exercise Notice.
The purchase price mechanism typically reflects a percentage discount from the market value at the time of exercise, often also including additional deductions for an option fee and planning promotion costs. The process of agreeing a price can be difficult because there is no transaction that takes place whereby the market value is determined by competing bidders on the open market.
If the landowner and option holder cannot agree on a purchase price there should be provisions in the agreement on how to resolve the dispute. This normally involves the appointment of a suitably experienced Independent expert or arbitrator who is also a chartered surveyor. The expert can either be agreed between the parties or appointed through the RICS.
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Our team is well versed in dealing with all the various aspects of creating and advising upon option agreements and we are here to help in any way we can. We are able to explain clearly the legal issues and provide open, honest and professional advice.
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It is important for you to be well informed about the issues and obstacles you are facing. However, expert legal support is crucial in terms of reducing risk, saving you money and ensuring you achieve a positive outcome.
To speak to our Commercial Property solicitors today, simply call us on 0345 901 0445, or allow a member of the team to get back to you by filling in our online enquiry form. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
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