What is an option agreement?
An option agreement is where a prospective buyer, in this case the developer, enters into an agreement with a landowner for the right to buy their land. The developer then has the option (within a period defined in the agreement) to buy the land. It is important to note that the developer has the option to purchase the land and is not under an obligation to do so. The developer will usually pay a sum of money to the landowner for the right to exercise the option, known as an option fee.
Why is an option agreement used?
Option agreements are a popular choice for developers as the option period allows the developer to pursue a planning application for their desired project without the risk that they will be obliged to buy the land without the benefit of planning permission.
How can an option agreement be useful for both me as a landowner, and the developer?
An option agreement can be a great choice for both the landowner and developer.
An option agreement is beneficial to a developer because it enables them to explore the viability of a development project without being committed to purchasing the land. It also provides security to the developer as they can do so freely without the fear that the landowner will sell the land to another party.
An option agreement can provide a great deal of flexibility for the developer because if it transpires that the development project is unsuitable, the developer can simply walk away and let the option expire.
Option agreements can also be beneficial for landowners because they can realise a higher price for their land without having to be directly involved in the planning process and without needing to invest their own money for the same.
How is the option exercised?
The developer will usually be required to serve the landowner with an ‘Option Notice’ and pay a deposit at the point they wish to exercise the option to purchase the land. Serving the option notice creates a binding contract for the sale and purchase of the site, with completion to then take place in accordance with the terms of the agreement.
What other types of contracts are available, and what are they?
Conditional contracts are commonly used between developers and landowners. These are contracts which are conditional upon one or more things happening before the contract can proceed to completion.
In this context, the contract will usually be conditional upon the developer obtaining satisfactory planning permission to develop the land that they intend to buy. A conditional contract can be an attractive option for a developer as they can secure the land under the contract so that if / when their planning application is successful, they can proceed with the purchase of the land. However, conditional contracts tend to give the landowner more power as the developer is bound to purchase the property unless the conditions under the contract are not satisfied.
Are there any practical considerations which I will need to consider with an option agreement?
We set out a few practical points below which you may wish to consider before entering into the agreement:
- Payments in addition to the purchase price: You may wish to consider indexation, overage payments and an arrangement whereby the developer pays for the legal fees you will incur as a result of entering into the option agreement.
- Lender’s consent to the option agreement: If your property is mortgaged, it will be prudent to consider whether your lender’s consent is required before entering into an option agreement with a developer.
- Retained land: If the option is affecting only part of the land which you own, you may wish to consider imposing covenants and / or reserving rights over the land which is subject to the option agreement.
- Financial and tax considerations: There will likely be tax implications which need to be considered and it is vital that you obtain separate tax advice in respect of these.
How long will my land be tied up for?
An option period can be for any length of time, but what is agreed between the parties tends to depend on the nature and scale of the potential development site. It is worth noting that during this time, the landowner will not be permitted to dispose of their property to another party.
For a relatively small parcel of land which is immediately available for development, an option period is typically around 1 to 3 years. However, larger sites may require a longer period in order for a developer to unlock its development value, with option periods ranging between 5 to 10 years.
It is also common for the agreement to provide for the initial option period to be extended in certain circumstances, for example, if a planning decision is still pending.
What happens if the option is not exercised?
It is important to remember that ultimately the developer has the final choice over whether to exercise the option. If they do not exercise the option during the ‘Option Period’ set out in the agreement, then the option will simply expire. If the developer has paid an option fee, the landowner will usually retain this and is free to deal with the land as they wish.
These agreements must be drafted very carefully to ensure that the option accurately reflects what is agreed between the developer and the landowner. Herrington Carmichael LLP can advise and assist with such agreements, as well as other contract options including conditional contracts and overage agreements please contact our Real Estate Team.
