Creative Property Contracts - Part 3 of 4 Part Blog Series
This is the third part of my series of articles on creative contracts. If you haven’t already, please do read my first and second articles in this series. As I’ve already written about the background in the first articles, I thought I would dive right into other creative contract structures in this article, along with some case studies.
Promotion Agreements
A promotion agreement is usually entered into between a seasoned developer or planning consultant (the ‘promoter’) and the owner of the property. Invariably, the property involved is land but it could include under-developed existing buildings. The objective of the agreement between the parties is for the promoter to apply for planning permission for a development on the property followed by the marketing of the property for sale on the open market once planning permission has been obtained.
The promoter funds the planning and marketing costs initially. If planning permission is obtained, the property is sold or, through an in-built option to purchase (see my first article), the promoter may purchase the property at a fixed price or the open market value of the property, depending on which is agreed. The price agreed will usually include the uplift in value as a result of planning permission being granted.
If planning permission is not obtained by a certain date, the agreement automatically terminates and the promoter’s costs are not reimbursed to the promoter - it being absorbed as a commercial risk/expense.
In the event of a sale in the open market, the promoter’s costs are reimbursed to the promoter out of the gross sale receipts and the promoter receives a proportion of the net sale proceeds.
If the promoter exercises the option and acquires the property, then the benefit to the promoter (the proportion of the net sale proceeds) is delayed until a subsequent immediate sale or the promoter builds out the development then either sells it wholesale or as new-builds to end-buyers. Another option is for the promoter to adopt a build to rent scheme, in which case a likely smaller benefit to the promoter will be realised when the promoter refinances the scheme - assuming some equity is left in the deal.
A promoter would usually only exercise the option to purchase the property if the time period agreed in the promotion agreement was about to run out and the onward sale of the property is not yet close to completing. This is a capital intensive way of realising the profit in the deal and given one of the main objectives of using the promotion agreement approach is to minimise upfront costs (see below), exercising the option is likely to be the last resort.
You would be forgiven for thinking that a promotion agreement appears very similar to an option agreement. Indeed some promotion agreements will include an option for the promoter to purchase the property, as set out above. There are some subtle differences between the two:
A promotion agreement tends to allow the parties to feel that they have a shared purpose - uplift the value of the property by obtaining planning permission then realising that value by selling the property on the open market. This shared purpose would enable both parties to feel that they are ‘on the same side’ - which is particularly helpful when the parties are negotiating. Contrast this with option agreements where the parties feel more like seller and buyer and thus take a more adversarial approach.
Avoiding an upfront payment - it is common in option agreements for an option fee to be paid by the developer/buyer to the property owner. I have seen these range from £1.00 through to £100,000.00! A promotion agreement, following on from the point above about being on the same side, doesn’t usually include an upfront payment to the property owner. This reduces the negative cash flow effect on the promoter, who merely needs to fund the planning application.
Flowing from the above point, the property could be one where the grant of planning permission could be a 50 / 50 proposition. It could perhaps sit in a green belt or just outside the local development plan. The promoter thus has to put in more effort and thus cost to obtain planning permission and so paying an upfront fee to the property owner wouldn’t be commercially viable.
Case Study
A recent case study I worked on involving a promotion agreement is a nursery - as in plants, rather than children. I acted for the property owner. He is in his late 70s, looking to retire and thus looking at legacy options . There is little value in the nursery business itself and so my client prefers not to pass this on as his legacy to his children and grandchildren. Besides, all of his children have pursued other careers so haven’t trained to operate the nursery business. He preferred to realise the value in the land instead, by obtaining planning permission to develop 4 or 5 new houses and redevelop an old derelict barn on the site. The barn previously had planning permission (this was before permitted development rights came into force) but that has since lapsed.
The property is located just outside the local development plan but there is a public consultation underway to extend the local development plan, which could thus include my client’s nursery. My client didn’t know anything about this but clearly the developer-promoter did, hence why the promoter approached my client using a direct-to-owner letter. Another nursery about 300 metres away from my client’s nursery had recently been developed into a residential scheme so the promoter was confident they could secure planning permission on my client’s nursery.
My client recognised that he did not have the expertise to pursue the planning application himself and did not want to expend the cost or hassle/time engaging a planning consultant to undertake the process himself. He was happy for the promoter to undertake this risk, so long as my client’s minimum (or floor) sale price (£2 Million) was achieved. This is the price below which my client would not be obliged to sell the property. He would however share in any uplift if the promoter was able to sell the property for an amount that was higher than my client’s floor price + the promoter’s costs, which was capped at £80,000.00. The cap was important as we wanted to ensure the promoter was not squeezing more out of the deal for themselves by marking up the planning costs.
The promotion agreement provided for the gross sale proceeds (being the amount above the floor price and the promoter’s costs less any disposal costs) to be split so that 60% went to my client and 40% went to the promoter.
This promotion agreement between my client and the promoter provided for a time period of 3 years before it automatically expires. If a planning application or appeal thereof was pending, then the time period was automatically extended by a year. These are indicative time periods - each promotion agreement is different so different time periods can be agreed upon on other deals. There isn’t a standardised time period across all deal type nor for that matter is there a standard percentage split between the promoter and property owner - it comes down to what you can negotiate.
Exchange with Delayed Completion
An old favourite, exchange with delayed completion (‘EDC’) is widely used to tie up property deals. In England & Wales, the norm is for completion to take place 7 or 10 days after the contract is entered into - commonly referred to as ‘exchange of contracts’ (albeit there is actually only one contract but signed in two parts. This is then exchanged between the parties so that following exchange one party holds the contract signed by the other party and vice versa).
With an EDC deal, completion is delayed by whatever period that the parties agree. The longest period of time in an EDC deal I have acted on was a year - that’s from exchange of contracts to completion. There is however no common period - no standard here - it is very much whatever the parties agree.
There are a whole raft of reasons why a seller and buyer want to commit themselves by way of contract to a sale and purchase of property, yet delay completion beyond the usual 7 or 10 days. Here are some common reasons I have come across over the past few years:
The buyer or the seller needs to obtain planning permission to regularise or convert the Property. Completion of the contract could be conditional on the grant of planning permission or where planning permission is very likely to be granted, the parties may well agree to simply delay completion by a longer period of time to account for the planning process;
The buyer wants to arrange finance but needs a longer period of time to do so - this is particularly common where private investor funds are being arranged;
One or both parties are waiting for an event to occur - this could be any event; for e.g. the buyer’s refinance or another property being sold, an Act of Parliament being passed (see Case Study below) or a linked transaction (such as on an assembled site deal - see future article) completing. It could also be that the Seller wants the certainty that the Property is sold but wants to complete the sale in the new Fiscal (Tax) Year
Case Study
This case study dates back to the time before the conversion of offices into residential apartments was a permitted development right under planning laws. At the time, this policy was still in the public consultation phase. My client - the buyer, was confident that the legislation would be passed. Even if it didn’t, my client had a ‘plan B’ for the block.
The delayed completion didn’t bother the seller - as a registered charity, they were exempt from business rates and had no borrowing on the property so weren’t particularly under pressure to complete the sale quickly. In fact, at the time, the property - formerly their headquarters - had been lying vacant for some time and it took a long time for a buyer to be interested in the site. It’s been a very different market since the permitted development rights were passed of course - most office blocks being snapped up very quickly - for conversion into residential apartments.
So the deal was struck, contracts were exchanged and my client and the seller agreed to a fixed completion date - 1 year after contracts were exchanged. In the meantime, the legislation had been passed and the conversion of offices into residential apartments under planning permitted developments rights was enshrined in law. Following completion, my client set about converting the office block and has since let the various flats on ASTs.
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