The Best Options in a Falling Market
It would be a clear understatement to say that property developers are having a hard time at the moment, being at the forefront of the credit crunch and a falling property market.
It is all too easy to purchase a site based on assumptions about final sales values that, as planning and development proceed, begin to look increasingly over-optimistic. You might then need to make difficult decisions about what to do with an uneconomic site: building it out might be pointless if a profit cannot be made; buyers may be hard to come by; and capital locked up in existing sites may prevent further acquisitions. Selling the site quickly, even at a loss, might even be the best option.
One solution to the problem of the falling market is to adopt an appropriate acquisition strategy. A good strategy would be one that helps you delay paying for the site for as long as possible and ensures that, when you do pay, you get the best price possible and based on market conditions then rather than now. This can be achieved by using option agreements.
An option gives you the right to acquire land at some point in the future, rather than now. This enables you to apply for and obtain planning consent for development of the site before you are committed to the purchase and have to pay for it.
It can also be used to prevent you becoming legally bound to a deal at too high a price.
How effective an option agreement is in achieving these objectives depends on its specific wording and this is where a lawyer who knows all the ins and outs of option agreements can prove to be your best ally. Your lawyer can help negotiate the terms of the agreement to ensure you pay the best price possible when you come to exercise the option.
There are a number of ways of achieving this technically and they can be very complex, but a well-drafted agreement can work wonders in achieving this outcome. These are two examples:
- careful drafting of the term Net Development Value to ensure the price paid for the site is calculated net of all development costs including developers profit. Such an approach also insulates you against rising costs between the negotiation and exercise of the option;
- linking the price of the land to a well-known house price index such as those prepared by Nationwide or HBOS. If you adopt this approach in a falling market, you will want to use the index you believe is the most forward looking, as this is likely to reflect falling prices much earlier than a more backward looking index such as the Land Registry House Price Index.
You will need to work closely with your lawyer and valuer from the outset and during the initial negotiations. Choose a lawyer with experience in negotiating option agreements, who understands your objectives and achieves them through the negotiation of initial heads of terms to the drafting and implementation of the legal agreement.
Steve Petty, Cousins Business Law, 01926 629005.