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Development risk and costs between landowners and developers

Who pays for the infrastructure supporting development?

The size and nature of any development scheme will usually determine who is responsible for and who pays for infrastructure costs which can either make or break a Greenfield development of any significant size.  

Access and services costs will always be a significant issue in any development process and these will need to be solved before the viability of any scheme is considered.  It is not unusual for a landowner to try and solve these two issues first before placing development plots on the market, as if there is already a mapped out solution the value of the development land will usually be considerably enhanced.  However, the real impediment to the landowner resolving infrastructure issues will be the detail of the proposed scheme and very often although the landowner has his land, he may not have the funds or the expertise to work up a detailed scheme, which would mean front loading costs without particular end users in mind.

The expenditure on the infrastructure costs will also only be worthwhile if the enhanced development value is available to the landowner, as there is no point having high quality roads and services if you do not get planning consent for the projected development.  Therefore, the negotiations between the landowner and the developer may invariably include the developer putting in the infrastructure, but with the landowner making its contribution by either a reduction in the price or even delayed payment of the price.  Unless the landowner has a large pocket he will not be able to fund the infrastructure works without planning consent for the development.

What costs need to be shared?

The costs which need to be shared are invariably costs relating to access and the provision of services.  However, for larger developments amenity costs may also have to be shared if additional amenities are going to be required in order to obtain planning consent.  This could be the cost of car parking, road works, road improvements or any other amenities required to make the scheme viable or attractive to the local planning authority.

Overage

Overage is a mechanism by which the seller of land can share in the increase in value of their land by receiving a payment in excess of the initial purchase price from the buyer after completion.  Payment of overage is usually brought about by a specified trigger event, for example obtaining planning permission or completion of the development. 

From a developer's point of view it is also a method of improving the initial cash flow of a development proposal and also of sharing the risk of developing the land.  From a landowner's point of view it is definitely a case of "jam tomorrow", so the landowner must not get too distracted by the promise of an overage when negotiating the initial price. 

I always advise clients that the biggest risks with overage are firstly policing it, secondly protecting it and, thirdly accepting that you may not get any more money at all.  You need to make sure this is taken into account in establishing the price, rather than being too dependant on getting a promised overage in the future. 

In any agreement where overage provisions are agreed the parties will need to agree on the regular reporting to enable the landowner to police the provisions.  Clear trigger points for payment also need to be agreed to make sure that both parties are clear about when payment is due and when payment will be made.  If you are using a formula then a worked example in the document is always a good idea. 

There are numerous methods established for securing and enforcing overage agreements that can protect the seller from a developer seeking to avoid overage payments, though none of them are entirely satisfactory.  The drafting should be crystal clear about when, how and by whom the overage payment is to be calculated.  Definitions of the land, the sale price, the overage period, the specified trigger events, the obligations of the parties and available remedies in the event of a dispute are also vital.

Clawback on future development

If land is being sold prior to development the financial outcome of the development will probably not be ascertainable at that stage.  Very often until planning consent is obtained neither party will know for certain the number of units, the rental or sale values and therefore what the true development value of the land is.  The landowner may therefore be happy to defer payment of the full price until this is determined.  Equally, the developer will always be happy to take the cash flow advantage of deferring payment on part of the price. 

It is quite unusual to see a claw back of part of the price by the developer as most developers would usually not pay any part of the price which is uncertain or unascertainable, but quite common to see overage payable to the seller.  If overage or claw back is agreed the key consideration will be how the payments due from the developer can be protected.  The best form of protection will usually be a legal charge, but if the developer is borrowing to pay for the land a charge may not be available and if it is, only a second charge behind the senior lender may be on offer. 

Some form of restriction limiting dealings without consent, against the title is another possibility. This is probably the most common protection used, although a restrictive covenant or creating a ransom strip are other possibilities.  However, whatever method is used, it will have to be monitored and progress checked from time to time.  A key area of dispute will also be what costs or deductions can be made to arrive at the overage payable.  It is important to agree development deductions in advance and to make sure that every head of expenditure which is to be an allowable deduction is agreed by both parties and set out in the provisions.

House builders deferring payments

House builders in particular like to defer payments until their unit sales have been completed and they can really accurately determine their profit.  Always remember that the period from negotiation through to completed sales will usually be many years.  If acting for a landowner try and go for a formula which does not require you to wait until the last house is sold to get your money.  Obviously, some sales will be required but payments can be made on the basis of the first slice of sales with some final reconciliation at the end.  The developer will understandably want to wait until all sales are done and all costs are in.  As ever, the final bargain will depend on the negotiating skills and power of both parties and will be a balance of their interests at the time the transaction terms are agreed.

The words 'development risks' can conjure up images of delayed construction works and misconceived architectural plans, but it does not have to be fraught with mishaps if both parties set out there position and these are mapped out in the agreement between the parties.  However, there are plenty of challenges facing a landowner who sells to developers.  Some of these risks can be over come by careful consideration of the issues and good planning of what is required on both sides for the arrangement to bear fruit for both parties.  Good advice at the earliest opportunity is also a must.

This article originally appeared in the RICS Land Journal in May 2015. It was written by Karen Mason, a partner in the Property team

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