Posted by Peter Foskett, Partner
The Brexit consequences for Land Development Agreements
If you’ve entered, or are about to enter, into an option or promotion agreement which currently remains in force, you may be concerned about the likely consequences of the development market weakening as a result of the referendum decision to leave the European Union.
By way of background, Option Agreements are agreements by a landowner with a party to obtain planning permission for development, as a pre-condition of being allowed to buy the land. Promotion Agreements are agreements for a party to obtain planning permission for development so that the land can then be marketed to developers, and the proceeds divided between the landowner and that party.
If the agreement relates to a specific parcel of land, then it may well quote a fixed sale price for the land once planning permission has been obtained. In this situation, the Brexit decision may make it more likely that if a satisfactory planning permission is obtained, the purchasing developer may seek to re-negotiate the agreed price as a pre-condition of exercising the option, or it will delay exercising the option for as long as is permitted by the option agreement. These actions are likely to occur if the residential property market has weakened because of a general slow down in the British economy or mortgage funding once again becoming much harder to obtain.
If the purchase price under the agreement is a percentage of the land’s open market value with the benefit of planning permission, which will more typically apply to larger sites, and if the residential property market has weakened, the purchasing developer may again look to delay triggering the option for as long as possible, or seek to renegotiate the formula.
Alternatively, if it is cash rich it might decide to buy the land and land bank it, waiting for recovery in the market. This way it can profit from buying the land in when cheap and selling homes in a recovered and buoyant market. Unless the agreement contains a minimum sale price which was set reasonably high, the landowner may have no alternative but to sell and accept that it has received money today and passed the risk of how long it will take for the market to recover to the developer.
What are the implications upon agreements which are currently being negotiated?
The possibility of the residential property market weakening needs to be considered even more than usually is the case in the drafting of both option agreements and promotion agreements. The protections needed by the landowner are one or more of the following provisions:
- a robust minimum sale price so that the landowner cannot be compelled to sell the land unless the buyer pays the greater of that minimum sale price and the open market value. This will protect the landowner from a substantial fall in land prices, but may well still leave the landowner receiving much less than it had originally expected when it signed and entered into the agreement.
- a provision enabling the seller to delay the buyer’s ability to exercise the option agreement for a specified period of time, where the market value has fallen below a specified level so as to allow time for recovery of the market. Given that the planning permission will most likely need to be implemented within three years of its grant, that period of time will need to be relatively short.
- a clawback provision so that if the sale of the houses achieves a total figure greater than the estimated gross developed value at the time of the sale by the landowner, then an agreed percentage of that surplus will be paid to the landowner.
In the case of Promotion Agreements, these generally are drafted with a longer timeframe in mind and as such normally contain provisions (albeit generally worded) to address times when the market is weak. Nevertheless, one of the consistent tensions between parties to a Promotion Agreement is the desire of the landowner to get maximum value for the land, and the desire of the party that has paid for the promotion of the land to be repaid the substantial outlay it has made to secure the grant of planning permission. The promoting party may be willing to forego waiting so as to achieve a higher marker value so that it can be re-imbursed for its outlay more promptly than would otherwise be the case.
Promotion Agreements being entered into now should address more specifically than has previously been typical, not just the issue of a weakened residential property market, but also such weakened state subsisting for a long period of time. There should also be greater scope to negotiate a longer period of delay in a Promotion Agreement for marketing and sale of the land than will be possible in an Option Agreement.
One thing to be borne in mind is that there has been a substantial shortfall in the building of new homes for very many years, so that there is a need for them. The crucial factors are the availability of mortgages for people to buy them, the strength of the economy to give buyers the confidence to borrow the funds, and developers having the confidence that they can make a profit from buying land and building homes. While the consequences of Brexit might influence these factors, the underlying demand and need for new homes will not only remain but grow due to the demand not being fulfilled.
Hopefully after the initial shock of the result, business will return to normal as people realise that the process of leaving the EU will not take place immediately.
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