Not the best option

Option agreements with developers are unlikely to safeguard the interests of selling landowners, and promotion agreements offer a better solution

The Journal, January 2007, page 46

Until recently, when a housebuilder arrived at your door promising riches beyond belief in exchange for those two fields either side of the new bypass, there was one way to agree a deal: a traditional option agreement.

Under such option deals, the landowner would receive an initial cheque, for a welcome but often far from spectacular sum, while the housebuilder would depart with an option to buy the land, during an agreed period of time, once they had been successful in securing planning consent for the site.

Smile on the tiger

The serious money only changed hands when consent had been secured, normally at an agreed discount to market value. The discount – typically between 10 and 30% – supposedly reflected the cost and risk to the housebuilder of securing that consent.

Despite eventually having to hand over a cheque for what could easily be a seven or even eight figure sum, the housebuilder could often be seen walking away from a successfully executed option deal with a pleased smile on his face. That was because the housebuilder had just made an awful lot of money, thanks to a form of contract that was always loaded in their favour.

Option agreements do still have a place, particularly when it comes to small sites, but owners of larger or more complex landholdings, with genuine hope value, should steer clear. Sign one too hastily and you could be making a mistake that could cost you, quite literally, millions of pounds.

Now, thankfully, an alternative to the traditional option has emerged, in the form of the promotion agreement.

Unequal match

To fully appreciate the benefits of the new mechanism, you have to understand what is wrong with the old-style option.

Under an option agreement, the interests of the two parties are clearly and totally mis-aligned. The landowner wants to sell his land for as much as possible, while the housebuilder wants to buy it for as little as possible.

This mis-match is so obvious that in recent years option agreements have been wrapped up with all sorts of additional terms and conditions designed to redress the imbalance between the two sides. The usual result is vastly more paperwork, higher legal costs and a not always satisfactory outcome.

There are further problems. Take s 75 agreements – so-called planning gain – which effectively see the landowner agreeing to pay for various infrastructure improvements in exchange for their getting planning consent.

Under an option agreement, it suits the housebuilder to agree readily to the planning authorities’ s 75 requirements for two reasons: not only do they get their planning consent sooner, but the cost of the s 75 agreements reduces the market value of the land. As a result, it’s the landowner who loses out.

Then there is the contentious issue of market value. Either the two parties eventually agree a figure somewhere in the middle ground or a professional valuer, brought in to arbitrate, will do it for them.

Securing a premium

Either way, because of the conservatism inherent in any valuation exercise, the agreed, so-called market value can easily be 20-30% below the actual market value and anything up to 50% below what one particular buyer with a vested interest might pay for it on the open market.

Premium prices are never reflected in valuations, but are far from unknown in the development land market. Again, under an option agreement, it is the landowner who misses out and, as our case history shows, it can be to the tune of millions of pounds.

However there is a solution, the promotion agreement, and we can think of no more powerful indication of their efficacy than the fact that housebuilders don’t like them at all. For landowners facing a once-in-a-lifetime opportunity and understandably anxious to make the most of it, they are undoubtedly the answer.

Under a promotion agreement, a landowner enters into an agreement not with the company that will eventually build houses on the site, but with a specialist promoter.

Planning before bidding

Once again, a limited upfront premium may be paid, but essentially the promoter takes on the risk and costs of the planning process and in return he or she takes an agreed percentage, not of the market value but of the actual selling price. That is the key difference: when planning consent has been secured, the site has to be sold to the highest bidder.

With both landowner and promoter having a vested interest in the final selling price (normally the promoter takes 10-20%), both sides will be very keen to see the best possible consent granted in the minimum length of time. Both parties, for instance, will be similarly aligned when it comes to planning gain: willing to give away the minimum required to secure consent but absolutely no more.

Promotion agreements have been with us for a few years now and a proper market for them is beginning to emerge. In certain parts of the country, half a dozen specialist promoters will now be competing for the best sites, ensuring that landowners can be confident of getting the best deal. Even some housebuilders are reluctantly coming round to them, but usually as part of some complex hybrid deal for large parcels of land, where part of the land is held under option and part under promotion agreement.

Most landowners, however, should stick out for what – nine times out of 10 – will undoubtedly be the best way for them to structure the deal. Promotion agreements are definitely here to stay.

 Sinead Lynch, BSc(Hons), MRTPI is an associate at property and land specialists Strutt & Parker, based in the Planning & Development Department at the firm’s Edinburgh office

PROMOTION AGREEMENTS: THE BASICS

Under a promotion agreement, a landowner enters into an agreement not with the company that will eventually build houses on the site, but with a specialist promoter. Essentially the promoter takes on the risk and costs of the planning process and in return he or she takes an agreed percentage, not of the market value but of the actual selling price.