An option agreement is where a prospective buyer enters into an agreement with a landowner for the right to buy their land/property, often paying the landowner a sum of money as an option fee.
The prospective buyer then has the option (within a period defined within the agreement) to buy the land/property.
Is the developer obliged to buy the land?
No. The developer has 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 expire. If the developer paid an option fee, the landowner will retain this and is free to deal with the land as they wish.
How long is an Option Period?
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. For a relatively small parcel of land which is immediately available for development, an option period is usually around 1 to 3 years. However, larger scale sites tend to be “strategic land” and require a longer period in order for a developer to unlock its development value. Option periods for strategic land vary, but one common period is 5 to 10 years.
The initial option period may be extended in certain circumstances (for example, if a planning decision is still pending) if the parties have agreed this within the agreement.
How do you exercise the option?
The developer will usually be required to serve an ‘Option Notice’ and to pay a deposit at the point they wish to exercise the option to purchase the site. Serving the option notice creates the binding contract for the sale and purchase of the site, with completion to then take place in accordance with the terms of the agreement.
Why would a developer want to use an option agreement?
An option agreement will provide that the landowner cannot dispose of the land to anyone else during the option period. This allows a developer to explore the viability of a project and pursue a planning application during the option period, without being committed to purchasing the land and without fear that the landowner will sell it to another party. The decision then lies with the developer whether to exercise the option if they consider the project to be commercially appealing.
Where a developer is assembling a site or has an existing development, an option over neighbouring/adjoining land may be appealing as it gives a developer the freedom to expand a site at a future date.
Why would a landowner want to use an option agreement?
A landowner may recognise the fact that their property/land has significant development potential, but do not have the resources or expertise to pursue a planning application themselves in order to maximise the value. An option agreement provides for the landowner to profit from the enhanced value of their land as a result of planning permission being granted, without having to go through the planning process themselves. The landowner may also receive an option fee.
Are there disadvantages of using an option agreement?
As with all types of transaction, there may be certain risks involved in entering into an option agreement for both parties.
The developer may incur significant costs and spend a lot of time in pursuing a planning application, which is either not successful or is granted but on unsatisfactory terms. In such situations, the developer is unlikely to exercise the option and so would have to absorb the losses.
As mentioned above, landowners are not permitted to dispose of their property to any other party whilst the option agreement remains in force. There is no guarantee that the developer will purchase the property under an option agreement given that exercise is their choice. As such, a landowner may be restricted from dealing with their own property for many years and for the sale to not proceed at the end of it.
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 (conditional contracts, overage, promotion agreements etc).
