Creative Property Contracts - Part 4 of 4 Part Blog Series

This is the fourth part of my series of articles on creative contracts. If you haven’t already, please do read my previous three articles in this series. So far, I have written about:

• Option Agreements

• Joint Venture & Collaboration Agreements

• Assisted Sale Agreements

• Vendor Finance

• Overage Clauses or Agreements

• Conditional Contracts

• Promotion Agreements

• Exchange with Delayed Completion

If you haven’t read my previous articles on the above, then ensure you order the previous editions and catch up!

In this edition, I am writing about:

• Title Splitting

• Pre-Let Agreements

• Pre-Emption Agreements

Title Splitting & Development Site Assembly

Title splitting is when a freehold or leasehold title to a property is carved up into more than one freehold or leasehold titles, thus carving up the property into (usually) smaller parts. The common type of transactions I have worked on include:

• Carving up a large plot of freehold land into smaller parcels of land, each with new freehold titles

• Splitting a block of flats (sitting on a freehold title) into leasehold titles - one per flat

• Splitting a mixed use block (sitting on a long leasehold title) into leasehold titles - one per flat and commercial unit

• Carving up back-gardens of various houses into a single development scheme but which are consolidated into a single freehold title across all the plots of back-garden land. This is commonly referred to as land assembly or development site assembly

Title splitting is a fantastic way to add value to a property. For example, in the block of flats type of transaction above, mortgage lender underwriters usually prefer to lend on one or more residential long leasehold titles rather than one freehold title of all the flats. They consider the ability to sell these in the open market, in the situation where there has been a repossession, much easier than selling a block of flats all on one title - the market demand for the latter being much more restricted. From an investor’s perspective, it should also prove safer and easier because:

• The mortgages will be on residential BTL terms, rather than a commercial mortgage. Residential BTL mortgages tend to be easier to arrange and the mortgage conditions are usually ‘softer’ than commercial mortgages

• The mortgages can be spread over a few lenders, rather than the entire block concentrated with one lender. This spreads the risk of lender collapse or lender calling in the loan

• Multiple residential BTL mortgages also makes it easier to spread the timings of loan product expiries and thus the timings of when the properties need to be refinanced

I could go on about title splitting - it’s a fairly large topic. Indeed large enough that I have run day long courses on it! Visit my Academy if you would like to watch an introduction webinar on this topic.

Pre-Let Agreements

A pre-let agreement sets out the letting of a property at a future date. It is commonly used by developers or landlords and operator tenants in agreeing a pre-letting of a property before the property is fully built or refurbished. Here are some examples I have worked on:

• a developer building a mixed use scheme, consisting of ground floor retail unit(s) and residential upper parts. The ground floor retail units were pre-let to Sainsburys a few months after planning permission was granted but before constructions works started

• a landlord pre-letting various retail units to occupier tenants with stronger covenant strength as part of a value-add exercise to the portfolio. This consisted of an extensive refurbishment scheme, replacing weaker covenant tenants or tenants that wouldn’t fit into the new scheme and enhanced landlord led services, including marketing to attract more footfall

• a hotel developer pre-letting a 125 bedroom new-build scheme to an international branded hotel operator

The pre-let agreement gives the developer or landlord some certainty that there will be little or no void in the scheme once the construction works are complete and other conditions have been met. It also enables the developer or landlord to raise finance against the security of the pre-let agreement as lender underwriters look favourably on a scheme that has an assured income-producing exit.

Key Issues to Consider

• Expect the legal process to be arduous - the lawyers are trying to protect each party and are pretty much ‘crystal ball drafting’ to provide for the various possible scenarios that may arise

• Be prepared to produce plans and specifications much earlier than you thought - part of the prospective tenant’s due diligence and legal process will involve careful review and planning for the type of space that the prospective tenant will expect, upon completion, failing which they can walk away. This could be a challenge if you are still early in the development cycle as you may not yet have these details

• Expect major snagging issues - once the construction works are complete, expect the prospective tenant’s snagging team to assess the property with a fine tooth comb. They will usually return with a long light of snagging issues but from experience, they are merely adhering to what was expected and legally documented at the outset.

On the plus side, tenants such as the likes of Sainsburys and Tesco Express have established processes and teams that frequently deal with pre-let agreements so they have clear requirements and documentation. Whilst this remains arduous, it does give you a framework to deal with and so becomes just a matter of checking off the right matters.

Pre-Emption Agreements

A pre-emption agreement, sometimes referred to as right of first refusal, is usually given by the property owner or landlord to the other party to the agreement. In the agreement, the property owner / landlord agrees not to dispose of his property without giving the grantee or the beneficiary the opportunity to buy in preference to anyone else. The agreement is usually given for a fixed period of time, after which the right of first refusal automatically terminates. Unlike an option agreement (see my first article) a right of pre-emption imposes no duty on the property owner or landlord to sell his property; he may sell or not, as he pleases and, if he decides to sell, the grantee will be in the position of a preferred purchase.

Advantages

• A developer acquiring neighbouring land for development may find it useful to be the preferred buyer - this is particularly helpful if the developer does not want a competing scheme or developer working on the neighbouring property

• Similarly, a pre-emption agreement could be useful in a development site assembly situation

• A tenant occupier may want the security that they could own the property rather than have a new landlord, who could be difficult to deal with

Key Issues to Consider

• Price to be paid for the property 

This needs to be specified in the agreement. It could be a fixed sum or the open market value of the property or the price at which the property owner is prepared to sell or a sum equal to the price offered by a third party on bona fide arm’s length basis.

Whatever purchase price or purchase price calculation methodology is specified, the agreement should include a dispute resolution clause. If the purchase price is the open market value of the property, then in default of agreement between the parties, it will need to be determined by an independent surveyor. It could be necessary for an arbitrator to adjudicate the dispute.

Ideally, the agreement should provide a relatively detailed calculation formula to determine the purchase price at the time the right of pre-emption is exercised, with worked examples. This will set out the parties’ intention which will assist the independent surveyor or arbitrator in resolving the issue of the correct purchase price.

• Trigger Events

The agreement should set out the event(s) that will trigger the grantee’s entitlement to buy the grantor’s property. The parties will need to discuss and agree whether any disposal of the property (for e.g. a letting or refinance) would trigger the right of pre-emption or only certain disposals, such as a sale.

From the grantee, especially developer’s perspective, the pre-emption right should be expressed as widely as possible so that it catches any possible disposal or attempt to dispose of the property. This could for e.g. include even a refinance of the property by the property owner.

• Duration of the Right & Consequence of Not Exercising

Just like the purchase price, the agreement should clearly state for how long the grantee benefits from the right of pre-emption. Expressed another way, this is how long the property owner is legally obliged to first offer to sell the property to the grantee.

Naturally, the grantee should try and negotiate the longest possible period of time but expect to pay some form or premium or incentive to the property owner, the longer this period is.

If the property owner does not try to dispose of the property during the fixed right of pre-emption period or the grantee does not exercise the right, even if the property owner offers it to the grantee, then the right of pre-emption will automatically terminate upon the expiry of the pre-emption period, without the need for further action by either party.

I hope the above was useful. If you would like to discuss the above or other creatives deal structures, feel free to book a consultation: https://bit.ly/TMConsult