Advantages & risks of option agreements
If you have realised your property may have development potential and need help to redevelop it yourself, entering into an option agreement with a potential buyer may be a great avenue to explore.
But what is an option agreement, and what risks are involved? In this article, we will delve into all things option agreement.
What is an option agreement?
An option agreement or option contract is where a prospective buyer creates a deal with a landowner for the right to buy their property/land; usually, there is a lump sum payment known as an option fee.
An option agreement is usually oriented around obtaining planning, allowing time for a site to be promoted through the planning process and for Satisfactory Planning Permission to be accepted.
The prospective buyer then has the option to purchase the property/land within a predefined period known as the option period.
The land use for an option agreement can be for residential or commercial purposes.
How is the purchase price agreed?
The purchase price usually reflects a percentage discount from the market value during exercise. Agreeing on a fee can be challenging as competing bidders have yet to determine the matter on the open market.
The landowner and the prospective buyer will negotiate the potential market value of the land, considering the costs of development and eventual profit. Market conditions and comparable land transactions will also need to be considered.
A minimum price provision within the agreement will prevent a sale unless a specific price threshold is attained.
If neither party can agree on a price, a suitably experienced independent expert like a chartered surveyor will visit the property and determine a purchase price.
Is the prospective buyer obligated to buy the land?
The prospective buyer is not legally obliged to buy the land; the agreement will expire unless they purchase the property within the option period. If the prospective buyer has paid an option fee, then the landowner will keep the payment and is free to retain ownership of the property.
How long is the option period?
The option period can be any length but must be agreed upon by all parties involved. If the prospective buyer is a developer, the option period will depend on the scale of the potential development on the site.
Occasionally, all party agreements may extend an option period due to unforeseen circumstances like planning permission pending.
A relatively small property that can be immediately available for development may have an option agreement of 1 to 3 years, and a property with strategic value may have one for 5 to 10 years.
How do you exercise an option agreement?
The prospective buyer will serve you an option notice and pay a deposit when they wish to start the process.
The prospective buyer will then be able to explore the project's viability and pursue planning permission without being committed to purchasing the land and without fear that they will sell the property to someone else.
If all goes well, the prospective buyer will purchase the property at the end of the option period.
What are the benefits of an option contract?
As a landowner, you may recognise that your property or land has significant development potential, but you may need more resources to utilise the space.
An option agreement allows you to profit from the enhanced value of the land because planning permission is granted without having to go through the planning process yourself.
You may also benefit from the prospective buyer's additional option fee, regardless of whether they decide to go forward with the purchase. The option fee is an additional deposit on top of the purchase price payable for the land.
If the land is developed, then there is an increased land value which you may wish to utilise and share in the developer's profits; this can be done as an overage agreement, which is an agreement to share the proceeds from a future sale with the original seller.
What are the risks of an option agreement?
As with all investments or property ownership procedures, there is a certain level of risk.
The prospective buyer may incur high costs and spend significant time pursuing a planning application, which is either unsuccessful or granted but on unsatisfactory terms.
In this situation, the prospective buyer is unlikely to exercise the option and would have to absorb the losses.
As the landowner, you cannot enter into any other agreements with other prospective buyers whilst the option agreement remains.
There is no guarantee that the prospective buyer will purchase the property under the option agreement; it can seem like a very risky avenue to sell land.
You should also ensure that any paperwork is checked by both your solicitors and the prospective buyer's solicitors. As the process is not legally binding, poor wording in an agreement could cause a scathe of issues.
These agreements must be drafted very carefully to ensure that the option accurately reflects what is agreed between the parties.
Selling a property through an option agreement can be between 1 and 10 years long! Especially when you compare it to a service like ours —- we can buy your property for cash in as little as seven days.
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