The advantages & traps of option agreements

An option agreement can be utilised when a developer is considering purchasing land for development. It grants them the ‘option’ to purchase land for an agreed-upon price (or price mechanism) within a certain time period.

Why use an option agreement?

An option allows the developer to take on the risk and expense of applying for planning permission, safe in the knowledge that – if they are successful within the given time frame – they will be able to purchase the land at a pre-determined price. On exchange, an upfront sum (or ‘option fee’), is normally payable to the landowner. This is typically deducted from the purchase price if the option is exercised, but non-refundable if the option is not exercised.

The purchase price may either be an agreed fixed price, or market value at the date the option is exercised subject to a percentage discount to reflect the developer’s investment. Either way, it will generally reflect the increase in land value attributable to the planning permission balanced with the developer’s time, money, risk and expertise in obtaining it.

Things for both parties to consider

• Should the option period be extendable, and – if so – should another option fee become due from the developer at that date?
• What longstop date should be put in place (so that the land will be released from the option at a certain date)?
• Should the purchase price be fixed, or should it instead be determined by a price mechanism? How will this figure be calculated?

Things for the landowner to consider

• Typically, the developer must apply for planning permission which maximises the development value of the land.
• How much control will you retain over the planning application? This may be particularly important if you wish to retain land surrounding the development site, as you will want to ensure that its value – both amenity, monetary and for potential development – is preserved.
• Is a ransom strip to be retained restricting future development on adjoining land and what rights will need to be reserved to preserve the development potential of any retained land?
• In the event the option is not exercised, will the developer be obliged to assign the benefit of any surveys, reports and drawings to the landowner?
• Does the developer have a good track record of obtaining planning permission? This is important as you will be restricted in what you can do with the land throughout the option period.
• How will your tax position be impacted? For example, VAT, capital gains tax and inheritance tax. Advice will need to be taken at an early stage to ensure tax efficiency.

Things for the developer to consider

• What restrictions on use and occupation of the land need to be put in place to ensure that the land remains viable to purchase throughout the option period?
• Will the landowner be able to deliver vacant possession on exercise of the option?
• Which costs will be deductible for the final purchase price on exercise?
• What compensation will need to be paid to the landowner in the event they lose out on subsidies/grants as a result of exercising the option, or disturbing the site during the option period?

Options are technical and often high value agreements. Advice should therefore be obtained by both sides to ensure that the best outcome is achieved. Please contact us if you have any questions or require support.

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