5 minute read
Overage agreements – what are they and why is their popularity on the rise?
Recently, the use of these agreements has seen a sharp rise and it is easy to see why – who wouldn’t want to make a bit of extra money long after the completion date of their land or property sale?
This article is aimed at property investors and developers seeking to gain a better understanding of the conditions under which overage agreements apply.
What is an overage agreement?
An overage agreement, or ‘overage’ is used when land or property is sold which is likely to greatly increase in value in the near future; a prime example is when land is sold to building developers. Where overage conditions have been written into the contracts during a sale, the seller may be entitled to receive a share of the profits when the conditions are satisfied.
Note that overage agreements can be specific to the property and the circumstances, including details such as whether a mortgage is involved, and duration of the overage. For this reason, one size does not fit all when it comes to quoting for legal advice on overage agreements.
What conditions can apply?
Sellers may receive a share of profits in scenarios where specific conditions apply, which can include:
- The grant of a new planning permission.
- The grant of planning permission for a new use of the land.
- The construction of houses which exceeds the specified number, or commercial development on the land which is larger than specified.
- The on-sale of the land in its present state, where the vendor fears that the purchaser may take advantage of a rapidly rising market to make a quick profit from the land.
What are the elements of an overage?
There are five key parts to any overage agreement:
- Duration of the agreement
Although 25 year provisions are common, 5-10 year overages are more reasonable and realistic for both parties. Extremely long agreements may negatively affect the future sale of land, especially to those who intend to invest a lot of time and money into developing the land, as buyers are understandably unwilling to share profits with a previous seller who has seemingly done nothing to earn it!
Ultimately, this part of the agreement depends on the intended use of the property, as well as any time sensitive restrictions that are imposed upon it. For example, if land was to be sold to developers who intended to build on the property ASAP, a five year overage may suit.
- What will trigger the payments?
The standard position is that the overage payment will be triggered when either commencement proceedings are taken after planning permission has been granted, or where the property is re-sold for a higher price with the benefit of added planning permission.
Caroline, one of our commercial property experts says: “It would be in the buyer’s best interest to ensure that the mere granting of planning permission does not act as a trigger for these payments, as this could cause a whole host of issues especially where the buyer has not yet attained the funds to pay off the overage at this stage.
“On the other hand, sellers should also be wary of falling into traps relating to payment triggers. It is vital that the trigger is not tied to any event which is likely to be avoidable, such as the sale of the last house on a development plot, as some developers have been known to not even attempt to sell the last house solely to avoid paying the costs!”
- How much will the payment be?
When deciding how much the payment will be and how the amount will be calculated, it is crucial that this is kept as simple as possible; this ensures that there is little chance of error and so the result will fully reflect the intentions of both parties.
Typically, the amount payable will be a percentage of the uplift in value derived from the planning permission, or the difference between the price the buyer bought the property for and the subsequent price it was sold for, where payment has been triggered by the re-sale of the property.
Our clients ask us how to calculate the amount. In most cases an open market valuation will be used. Land will be valued with and without planning permission on the same date, to ensure appropriate comparisons are made (not affected by inflation or economic events etc). In some cases, a certain fixed fee will be payable based on measurement, such as for each unit or square metre developed; in these situations it is important to be clear how these measurements will be defined.
- How will the payments be secured?
To protect their interest, it is important for a seller to ensure that these overage payments will apply to any future buyers of the land. The seller can achieve this by:
- registering a legal charge over the land – this may be impractical in some cases, as banks can be unwilling to lend against properties which already have charges against them
- granting the buyer a leasehold – rather than sell the freehold. By granting a leasehold with no rent this ensures that the payment of the overage remains as a tenant covenant and that future tenants will still be bound by it when they take up the lease
- retaining a ransom strip – this land can be sold to the buyer upon payment of the overage charges.
- Will the payment release the obligation?
It is vital in this area of the agreement that the wording is clear, otherwise problems and loopholes can crop up. We recommend seeking legal advice when setting out the terms of the agreement to avoid this situation.
In the majority of cases, overages will be a one-off payment based upon the initial, singular development of the property. However, this opens up the possibility that the developer may make a small value development in order to ‘clear off’ the overage before going on to make much larger and more valuable changes. Although this would help the buyer to get around paying high costs, it would be catastrophic to the seller especially in cases where the money was being relied upon. For this purpose, it is vital that some kind of good faith clause is written into the contract to prevent the seller from being exploited, or by stating that there is a minimum provision before overage will take effect, perhaps around 10%.
5 Top Tips to Take Away About Overage Agreements
- Ensure both sides seek extensive legal advice from the outset to ensure their rights and interests are protected.
- Make sure a reasonable duration period is set which is realistic for both parties.
- Consider how the overage will be protected and how this may affect the ability to sell the property on in the future.
- Ensure the formula for calculating the amount payable is clear and understood by both parties, simplicity is key.
- When considering the trigger points for the payments, ensure both buyer and seller are protected from all angles to avoid exploitation via loopholes and unfair terms.
Making sure you get the best deal and understanding leases can be tricky. If you would like expert advice, please contact our Head of Commercial Property, Caroline by email or phone for a free, no obligation discussion about securing your investment.
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