What is an option agreement?

Napthens - August 9th 2019

With a growing number of landowners across the region marketing their land for development, option agreements are growing in popularity as a method of structuring deals and harvesting interest from potential developers. We explore some key issues in relation to options.

What is an option agreement?

Option agreements are entered into between landowners and developers and essentially grant the developer an option to purchase the land by exercising the right at any time during an agreed ‘option period’ in return for an ‘option fee’. Option agreements are used where a developer is interested in purchasing the land for residential and/or commercial development and the developer would ordinarily use the option period to apply for and secure the necessary planning permissions required to proceed with their development. The right to exercise the option lies with the developer.

What are the benefits for landowners?

The landowner can demand payment of an option fee or premium from the developer in exchange for the right to exercise the option; this would be retained by the landowner whether or not the option is subsequently exercised. The option fee is also in addition to the purchase price payable for the land when the option is subsequently exercised.

The developer will apply for planning permission at their own cost and risk. This allows landowners to propose their land for development without having to go through the lengthy and costly process of obtaining planning permission themselves. Landowners can take advantage of the experience and skills that developers have when it comes to obtaining planning permission.

Once the land has been developed, it will have an increased market value and so landowners may also want to think about mechanisms by which they may share in the developer’s profits or uplift in the value of their land even after they have parted ways; known as ‘overage agreements’.

Is there a risk for landowners?

Entering into an option agreement does not guarantee a sale at the end of the option period. This is a risk for the landowner as they will be entering into an agreement for a number of years, restricting the landowner from selling the property to any other interested party without the guarantee of a sale at the end of the option period.

If the developer fails to obtain the required planning permission needed to develop the land, the developer is unlikely to exercise the option and the sale of the land would not therefore proceed. Option agreements allow developers to consider (and lock out) the possibility of acquiring land for potential development without being obliged to do so. Careful thought should therefore be given to the option period and option fee amongst other matters to mitigate against such risks.

Drafted and agreed diligently, option agreements can be a practical method by which landowners can offer up their land for development and reap the rewards of doing so, without having to be directly involved in either the planning or the build.