Louise Norris, Associate in our Commercial Property team explains what an option agreement is and why the parties involved in a land purchase transaction may want one.
An option agreement is an agreement entered into by a landowner and a potential purchaser (developer) of the landowners property. When the parties enter into the agreement, often an agreed payment is made to the landowner and in exchange, the purchaser is granted a contractually binding first option to purchase the property. The purchase must take place within the option period (which can potentially last several years) or as a result of a trigger event, such as planning permission being granted for the development.
Protection for the developer
The option agreement prevents the landowner selling the property whilst the developer is exploring the viability of the project thereby reducing the risk and potential cost to the developer. The land is not purchased until it is exercised by the purchaser, which can be predicated by a trigger event.
A developer may be able to agree the purchase price with the landowner at the outset of the option agreement. This means that there is certainty of initial costs and the developer may potentially end up paying less than market value. Often, however, any price is subject to the deduction of unanticipated costs.
Security for the seller
The property market has had its ups and downs over the past 10 years. An option agreement does not guarantee a sale. On entering into an option agreement, the landowner often needs to grant a standard security to the developer which means the seller cannot sell the land to a third party for the period of time agreed in the option without restriction. The downside for the seller is that if the developer does not obtain planning permission and pulls out of the option, the purchase would not go ahead.
A piece of land has a greater market value after a dwelling house has been built on it. Often an overage agreement would be negotiated alongside the option agreement, so that if the land was to increase significantly in value once developed, the seller is able to obtain an additional payment after completion which is calculated on the increase of value.
Option agreements and overage agreements can be positive for both the landowner and the purchaser but there are potential pitfalls that require careful navigation. Should you require advice, do not hesitate to contact a member of our Commercial Property team.