How overage agreements can boost profits from your land

Does your business own land that is ripe for development?  If so, how do you get the best value from a potential developer?  The price they pay will take into account the time and money they expect to put in, but you will also want it to reflect the likely increase in the value of the land.  This can be hard to predict, so sellers and developers often negotiate an overage – an additional payment which reflects that increase.  Overage agreements allow the seller to share the actual increase in land value without inflating the basic price paid by the developer.

Drafting an overage agreement is very complex and it is essential to get good legal advice from the outset.

Developers accept that landowners want a fair share of any increase in the value of their land, but they do not want to take all the risk of changes in the market or other unexpected events.  A well-drafted overage agreement takes away (as much as is possible) the guesswork and allows a fair division of the actual increase in land value.  However, if the drafting goes wrong, the parties may be left with expensive arguments over how much is payable and when.

An overage agreement is likely to be used alongside either a conditional contract or an option agreement.  Under a conditional contract, the parties are committed to complete the sale and purchase if and when the agreed conditions are satisfied.  An option agreement generally gives one party (usually the buyer) complete discretion over whether or not to exercise the option to buy the land, within an agreed period.  The potential buyer will normally pay an option fee, with the full value of the site payable if the option is exercised.

Overage agreements are useful alongside either conditional contracts or options because in both cases the ultimate value of the developed site will not be known at the outset.

Key questions which must be addressed in an overage agreement include:

When will the overage be payable?

There may be more than one possible trigger for an overage payment.  It is common to provide for a fixed additional payment when a key condition is satisfied, such as the implementation of planning permission.  Alternatively, or in addition, the parties sometimes agree that the developer will pay a share of any profit on resale of the site and on the sale or letting of completed units.  Arguments can arise if the overage agreement is not clear about how hard the parties have to try to satisfy any conditions or to achieve sales or lettings.

How is overage calculated?

 An overage agreement may include a formula by which the additional payments will be calculated.  These must be well drafted and checked carefully.  The developer will want to take their costs from sale proceeds or rent before overage is calculated and legal advice is crucial to define such costs correctly.

Will all sales trigger overage?

The parties may agree that the developer (or the bank that has provided finance) can dispose of the site without triggering overage, as long as the purchaser enters into a fresh overage agreement on the same terms.  Again, drafting is key and legal advice is essential.

Are there tax implications?

 Overage payments are part of the purchase price, so they have tax implications for both parties.  For stamp duty land tax (SDLT) purposes, the buyer can apply to defer payment until it is clear how much overage will need to be paid.  The alternative is to include a reasonable estimate of the likely overage in the SDLT return for the purchase of the land and make a second SDLT return and balancing payment when overage has been calculated.

Income tax, capital gains tax and VAT are beyond the scope of this article, but you must get professional advice on how to deal with the tax implications of overage payments.

Investing in good legal advice at the beginning will ensure that you get the best possible return on your land value and that you do not find yourself saying ‘if only…’ many years down the line.

For further information, please contact any member of the commercial property department at Forrester Sylvester Mackett on 01225 755621.

The contents of this article are for the purposes of general awareness only. They do not constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.

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