Using Development Agreements to Unlock Opportunities
Sign up to our newsletter to receive updates on our latest news for lenders, landlords, occupiers and developers.
On one level, every property development, at least in the earliest stages, is an example of a potential opportunity which may or may not be realised dependent upon the actions of the owner and any development agency they might employ.
The more possible variables that can be set in stone at the outset, in the form of a contractual agreement, the greater the likelihood is that a development will realise its’ full potential. Development agreements do just this, reflecting on all conceivable elements of a project, from the type and scope of any planning permission required, to the wider economy and the costs of things like raw materials labour and execution methods.
What is a development agreement?
In simple terms, a development agreement is a contract between a developer and another party, under which the developer will procure the construction of works on behalf of the landowner.
Obligations set out in an agreement of this kind will generally cover aspects such as costs, quality and timescale, as well as provision for the transfer of an interest in the property.
In real-world scenarios, a development agreement could be drawn up between a number of entities, including landowners, developers, purchasers, tenants and funders, with each agreement being uniquely tailored to the circumstances of that particular development. There are, however, certain elements which tend to crop up in virtually all development agreements, with the majority of such agreements being drawn up because:
- A developer owns the site or has the option to purchase it from a third party and will enter into an agreement to sell the site and build housing on it. In this case, the purchaser will generally pay a price for the site itself alongside a separate amount for the developer to procure design and construction work, a process which will include obtaining planning permission and any other consents needed for the development.
- A landowner is convinced the land has development potential, but lacks the expertise or time needed to pursue an application for planning permission or act upon any permission once it has been granted. The employment of an expert third party via the use of a development agreement will enable the landowner to realise the potential value of their land without the upfront costs and risk involved in working alone. Once the planning process is in motion the site will need to be supervised carefully to ensure that no adverse rights injurious to the potential of the development are acquired; as with the original planning permission, a developer or development agency is much more likely to have the expertise and time required to ensure that this is the case.
There are several different types of agreements, but almost all will see the developer also being installed as the main contractor, in the form of a pre-agreed building contract following the sale or letting of the land. If the developer is not a main contractor then the development agreement will set out the terms under which the developer will, upon sale or letting of the land, enter into a building contract with a contractor, as well as making all necessary professional appointments.
At the outset of the process all parties need to agree on the contractual structure of the deal and their own roles within that transaction. In some cases, for example, the developer might hold the title to the land in a special purpose vehicle (SPV) company created for the agreement, with works to be carried out by their own construction arm. In these instances, a specific building contract would be entered into as part of the development agreement, with the construction company providing all necessary warranties and guarantees.
Over and above these considerations most development agreements may also cover the following aspects;
- An agreement on what is to be designed and constructed and the standard of delivery. Pinning this down will require technical documents to be created and added to the development agreement, or in some cases a document stipulating minimum requirements such as an end user specification document. The purchaser may want to include provision to inspect the works and sign off the works on completion, or details of any third-party dispute-resolution process to be employed following any disagreement on whether the agreed quality threshold has been met.
- A timetable for the development, detailing when any property will be ready and – for larger developments – whether multiple properties will be handed over in phases or simultaneously. There will generally be target dates for specific phases of the development as well as an overall date for full completion. From the developers point of view it will be important to build in a degree of flexibility into the timescale to allow for unforeseen circumstances. Plus, if a third-party contractor is being employed, any ‘extensions of time’ clauses should also be reflected in the dates stipulated within the development agreement. The agreement should set out what happens if target dates slip (i.e. compensation payments), and what remedy the purchaser can obtain if the overall completion date is missed. An agreement on liquidated damages at an agreed rate is sometimes deployed.
- Agreements around the cost of the development, such as the price to be paid for the construction work and whether that will take the form of a fixed price or an amount based on agreed rates. The agreement should include details of how the purchaser can request any variations and a mechanism for dealing with any increases which arise. Even an agreement on a fixed price or lump sum basis will usually have financial relief clauses built in to deal with the possibility of loss and/or expense deriving from unforeseen delays in the construction and development. The purchaser needs to understand, the agreement, the circumstances under which the price might change, and should be clear that they have access to the means to deal with any such changes, while the developer will not want to make extra payments to a contractor which can’t be recovered from the purchaser.
- Property developments often don’t run smoothly, so any development agreement will need to include warranties, guarantees and details of how any defects will be dealt with. Robust warranties of this kind are standard within building contracts, of course, and should be carried across to the development agreement. The developer will want to include a clause freeing them from liability for the construction works from an agreed date after completion – generally 6 to 12 months – while the purchaser will be keen to ensure that the warranties which are in place will enable them to obtain recourse for any defects which emerge after this date.
These are the building blocks (no pun intended) of the bulk of development agreements, but there are also variations which better reflect more bespoke or intricate projects, for example:
- A Promotion Agreement – most promotion agreements see the landowner entering into an agreement with a third party that is to ‘promote’ the land and obtain planning permission (thus greatly increasing its value). Once the objective of the agreement has been met, i.e. planning permission of the type agreed has been granted, the property is sold on the open market and the proceeds divided in agreed shares between the landowner and the promoter.
- An Option Agreement – this works in the same way as a promotion agreement, except that the promoter, rather than receiving a proportion of the proceeds of a third-party sale, will be entitled but not committed to purchase the land at a pre-agreed discount by a certain date. This discount will generally be a percentage of the market value of the land once planning permission has been obtained. Conditional – a conditional agreement is a binding agreement to purchase the property if all of the conditions are satisfied for a pre-agreed price if planning permission is granted. This price will have been agreed at discount on the anticipated market value once planning is attached. The difference between this and an option agreement is that the promoter is obliged to purchase the land at the previously agreed price. The advantage for the landowner is the degree of certainty this type of development agreement offers. However, care and skill need to be exercised in the drafting of the conditions to ensure commitment once the conditions are satisfied.
- Overage – overage represents a shift from the other possible options, in that the property is sold before planning permission has been obtained. The post-sale agreement will include the right of the landowner to receive a payment if planning permission is subsequently granted and the value of the land increases. An overage agreement enables the landowner to realise some of the value of the land more quickly, but also introduces an element of uncertainty, as the Landowner loses control of both the land and the planning as there may not be an obligation on the buyer to pursue planning permission. The question of if and when the full potential of the site might be realised is therefore much less certain. From the point of view of a developer, an agreement of this kind is less attractive as it involves purchasing a property without knowing whether planning permission will be granted. However, most developers would only make such a purchase after some due diligence has been carried out and they are confident planning will b e granted. Quite often overage may be confined to the density or additional number of units.
Should you need support in creating a development agreement that reflect the unique requirements of your forthcoming or prospective project, please contact our specialist team at Newmanor Law for an impartial consultation.