The benefit of index linking purchase prices in uncertain times
During these uncertain times, both Developers and Land Owners alike may be keen to see purchase prices index linked in Option Agreements and Contracts which are conditional upon planning being granted.
What is Index Linking?
Index linking (also known as indexation) basically involves a recalculation of the purchase price (shortly before completion) to reflect any increases (or decreases) in the relevant index between the date of the contract and completion.
For example – if a purchase price of £500,000 was agreed and the change in the relevant index during the length of the contract is a 3% increase then the purchase price paid on completion would £515,000.
What Index should be used?
The Retail Prices Index is one of the best known indices – this is the consumer price indices which are used as the domestic measure of inflation in the UK. This index is frequently used in residential leases to reflect increases to ground rent. However, it is not necessarily the most appropriate for a land purchase transaction.
Potentially a more accurate index for such transactions would be the UK House Prices Index – in additional to a general index for the whole of the UK, there are also regional indices which may be more appropriate to use so that any increase/decrease reflects any changes in the regional property market rather than the national property market. However this index does not take account of inflation and therefore may require some adjustment to make it suitable.
Why would Index Linking be beneficial to me?
Where an agreement is being entered into for a fixed price and the land will be bound for several months or years, then it will be difficult for either party to be sure that the price agreed now will reflect market values in the future. The Developer does not want to pay more than the market value as it would potentially make the project unviable and the Land Owner does not want to receive less than the market value as it could affect their ability to buy a suitable alternative property in the future.
At the current time, Land Owners may find that Developers are offering purchase prices which are lower than they would expect for their land especially in view of the length of time that their land will be under contract – Developers are being cautious as they will be taking into account the amount of investment in obtaining planning consent, the value of the land and the cost and availability of materials to build out their development.
One way to try to balance both parties concerns is to index link the purchase price – so that if the relevant index has increased during the contract then the purchase price will be increased accordingly, and possibly if the relevant index has decreased during the contract then the purchase price will be decreased accordingly.
It is common place for a lower (initial) purchase price to be agreed, subject to indexation – where this is the case, the Land Owner should ensure that the indexation is ‘upward only’ so that their purchase price cannot decrease below the sum quoted in the contract.
In fact, Land Owners should be wary about agreeing potentially downward indexation because this could result in the purchase price being less than the Land Owner is prepared to accept. Therefore if downward indexation is agreed, the Land Owner may want a provision in the Contract either (a) setting a minimum price (being the minimum sum that they are prepared to accept); or (b) allowing them to terminate the Contract if the purchase price goes below the minimum price.
You will appreciate that there is a lot to consider when index linking a purchase price and we would be happy to discuss this with you; taking account of your particular circumstances.
If you require further advice regarding the effect of Covid-19 on your property transaction, or any other Real Estate matter, please contact Claire McSorley in our Real Estate department.
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to a particular matter.
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