Creative Property Contracts - Part 1 of 4 Part Blog Series

This is part one of a four part blog series. Look out for the other parts to be published soon.

During the Covid-19 lockdown, it has been widely reported, primarily in the mainstream media, that the property market has cooled. In many ways it has but my experience somewhat contradicts this. I am certainly being kept busy by my consultancy and legal clients. Enquiries in response to our direct to owner letter campaigns have also risen.

What I am finding is that investors and property owners are considering more creative strategies in structuring their property deals. The simple straightforward sale and purchase, especially at the right or discounted price certainly isn’t commotosed but creative deal structures are being more widely considered. I was thus delighted that Richard Bowser invited me to write about this, especially relaying what I am seeing on the coalface.

The main motivation behind the shift to more creative deal structures, as I see it, is that age old human trait - necessity is the mother of invention. The cooling of the property market, the inability to have properties valued and the slowdown in the property finance sector have all led to innovation. 

I have long held the view that every economic pause for breath (I’m intentionally avoiding the ‘R’ word) gives us the opportunity to behave like startup ventures. Remember those halcyon days? The business plan was a blank sheet of paper - you had inbox-zero, your venture was small and adaptable. To borrow from Mark Zuckerberg - you could move swiftly and break things. The Covid-19 led slowdown has delivered the opportunity for innovation and creativity. 

Property deals still need to be done and my experience shows that they are very much being done! Let’s turn to have a look at some of the contractual structures my consultancy and legal clients have been adopting.

Option Agreements

A long time favourite amongst property developers. I am seeing it being used by long-term hold property investors too, as a means to secure a property for a set period of time (the ‘option period’). 

My favourite definition of an option is the ‘right but not the obligation to purchase or sell’. An option can work both ways - a put option or a call option. This allows the seller the option to sell or the buyer the option to buy the property. In property deals, the more common agreement is for the buyer to have the option to purchase the property.

This structure allows the buyer to secure the property for a set period of time, during which they can apply for planning permission to develop the property or arrange finance or even to secure other properties. The latter is a strategy usually adopted by property developers when they are assembling a larger property development site - otherwise known as a land assembly deal.

I am finding option agreements particularly popular - between my consultancy and legal clients, I am usually working on at least a handful of option deals a week.

Joint Venture & Collaboration Agreements

A joint venture or collaboration is when two or more individuals or entities come together to work jointly on an enterprise. That enterprise can be for profit or not-for-profit (cancer related medical research or disaster relief charities are a good example of not-for-profit collaborative enterprises).

Joint venture and collaboration agreements tend not to fit into a set mould - they’re much more fluid, to reflect the heads of terms agreed in principle between the parties to the enterprise. This does mean that such agreements tend to require more bespoke and thus specialist level drafting.

One of the benefits of joint venture and collaboration agreements is that it allows for ownership of the property to remain static. The general principle is that a tax liability is triggered when property ownership changes or the right to change that ownership arises. This could thus have stamp duty land tax or capital gains tax or corporation tax implications. A joint venture or collaboration agreement can avoid the tax liability trigger because ownership of the property remains unaltered - in the hands of one of the joint venture or collaboration parties.

The joint venture or collaboration agreement will usually allow the non-property owning party to influence and control the property in order to promote the enterprise for which the joint venture or collaboration was entered into. One example of this is where a property developer with good experience and track record of the planning process joint ventures or collaborates with a property owner in order to promote the property and obtain suitable planning permission. When the planning permission is granted, there is a theoretical/paper-based uplift in the value of the property - commonly known as ‘planning uplift’ (sometimes mistakenly referred to as ‘planning gain’).

Another example is a seasoned project manager or construction manager entering into a joint venture or collaboration agreement with the property owner in order to build out the property.

The joint venture or collaboration agreement would usually provide for the property to be sold - either as a whole or in parts (such as new-build sales) or refinanced as the exit for the enterprise. Upon realising the exit, the profit is shared between the joint venture or collaboration partners.

Assisted Sale Agreements

An assisted sale agreement works very similar to a joint venture or collaboration agreement. These tend to be a little more ‘templated’, especially for those property investors who adopt this strategy frequently. By using a ‘cookie cutter’ approach to their business model and thus deal structures, the agreement can be standardised.

In my experience, an assisted sale agreement is most commonly used by a property investor who will be refurbishing a property so that it can be sold in the open market for a higher price. It works particularly well with probate properties.

Vendor Finance

There are occasions when change in the ownership of the property is unavoidable. There could be several reasons for this - the more common ones that I see include: the seller needing an immediate payment of funds or the buyer needing to raise finance on the property, which needs to be secured by a charge on the property or it could simply be that the buyer doesn’t have the full amount of liquid funds required to complete the purchase.

In order to reduce the capital outflow of funds from the buyer to the seller, the parties may agree that part of the purchase price can be deferred until a future date, despite the full ownership of the property being transferred to the buyer upon completion of the purchase. One form of this deferred payment arrangement is known as vendor financing. In this structure, the seller agrees to hold off on collecting all of the sale price from the buyer until a future date. 

A well advised seller would usually obtain some form of security against the buyer’s obligation to pay the seller the remainder of the purchase price. This can take the form of a debenture on the buying company or be a first or second legal charge registered on the title to the property, depending on whether there is a primary lender funding the buyer’s purchase of the property.

Overage

An overage can take the form of a set of clauses within an option agreement or sale & purchase agreement, or it can be a standalone agreement in itself.

In simple terms, I tend to describe it as ‘kicking part of the price negotiations into the future’. 

I’ll explain what I mean by way of an example. Let’s say a seller is stuck at a sale price of £1 Million but the buyer is only willing to pay £800,000.00 for the property. The parties want to do a deal but can’t bridge the gap between their respective prices. One believes the property is worth £200,000.00 more whilst the other is nervous about the state of the market. An overage allows them to bridge that gap by kicking that difference into the future.

What this means in reality is that the sale is completed at £800,000.00. The overage clause/agreement provides that if the buyer was to re-sell or refinance the property at some point in the future, let’s say 3 years, and the open market value achieved for the property is £1,000,000.00 - either derived through a sale or RICS valuation, then the buyer must pay the £200,000.00 to the seller.

An overage can also be used where a seller thinks a buyer will obtain planning permission for say 10 units on the land but the buyer thinks s/he will only get approval for 8 units. The overage clause/agreement will state that if the buyer obtains planning permission for 10 units, then the buyer will make an additional payment to the seller.

The overage is usually secured either by way of a charge or, more likely, a restriction registered on the title to the property. This ensures that any future buyer of the property is aware of the overage and the obligation to make an additional payment to the seller. For obvious reasons, a time period or other criteria is usually stipulated within the overage clause/agreement so that the obligation to make the further payment expires after the time period or other criteria has passed.

A Post-Covid-19 World

As you can see, my experience shows that property deals are very much being done and creative strategies are preferred. The above are just some examples but the list of different deal structures is extensive.

I expect more creative structures to be adopted going forward, as we come out of lockdown and the property market starts firing on all pistons again.

If you would like to discuss any of the above or other creatives deal structures, feel free to to get in touch.