Overage 3: Key provisions to make money
Enticing the right buyer
Getting the best price, whether at auction or in a private treaty sale, is about marketing. I cannot help with customer lists, postage, email updates and glossy brochures and catalogues. In this article I am concerned with identifying the potential buyers who will pay the highest (price plus overage) and making it likely that they will bid.
In the first instance it is up to the estate agent / auctioneer to assess the chance of your land ever “coming for development with a period of ten to twenty years. That can be only a guess. There is no point is interfering with a good sale lot with overage which could put off straight forward buyers. However, if there is some chance, then he should talk to his client.
There is no question that land subject to an overage is worth less than land that is not. Even a farmer will be reluctant to buy overaged land, despite having an intention only to farm it for the next 50 years. If the land is unlikely to come for development any time soon, the seller may well decide to forget an overage and maximise what will be in his bank account four weeks after the sale date. The agent can advise what land may be developable within a couple of years, but he will not pretend he can foresee the future.
On the other hand, if the agent thinks that a future owner of the land might just be skillful and lucky, he will present the land to the “developer” market and not simply to the local farmers and horse sisterhood (and fraternity, of course). The obvious fundamental point is that the value of the land is higher in proportion to the assessed chance of planning permission for high value development. Now I will look at the overage terms that will be written into the contract.
First, let me just mention that the very word “overage” is enough for many knowledgeable potential buyers to turn the page of the catalogue. Outrageous overage terms have been the norm for so long that all overage terms will be assumed to be outrageous. So some other term should be used. “Second payment” or “conditional payment” might do the trick.
Life of the overage right
A buyer for the medium to long term will most likely not be discouraged by a short life overage because she will expect to own the land for longer than the life of the overage. She will be a standard bidder at a price which discounts the overage. So if the seller wants to encourage bidders like her, he must keep the overage period to a maximum of ten to 15 years. Any longer, and the sales price will drop.
A professional developer will not be interested in an overage which continues for any length of time, after the first “bite at the cherry”, for reasons I will discuss in a moment.
Sharing the profit fairly
The prime marketing target must be a developer because obtaining planning permission for development maximises both the amount of the uplift in value and the likelihood of it happening. No developer is going to say she does not mind an overage payment. The bottom line is that if the seller wants to sell, he will no longer own his land, so any additional payment will be regarded by the buyer as something like a ransom. However, what matters to the buyer is what she is happy with her calculations of cash flow and ultimate profit.
Her calculation of profit will take account of the expenses of working on the project and all the payments to be made along the way. Today, a local planning authority may demand ten expert reports before they will even check the application. With developer’s staff time, plus a planning fee, even the cost of a simple application will run into £40,000-£50,000.
In many overage agreements, the terms are defined so that the overage is payable on the difference between what is effectively the purchase price of the land, on the one hand, and the value with planning permission on the other hand. So, if the buyer foresees problems and the possibility of a large “spend”, she could find that a 50% overage calculates out at 80% of the true profit. That is a non-starter. For her, it is essential that the overage calculation is based on profit and not on the increase in value of the land. There is no way she will consider a deal which fails to account for whatever outgoing is necessary.
The developer also has to cover the possibility that she might spend that money and still fail in her application for planning permission. After all, the seller has not had the courage to put out £50k at risk, so he cannot expect someone else to take that same risk without a high reward. The developer now owns the land. She has put out money at risk. She has spent staff time in managing the process. So if you seek 50% of the uplift, she will not look twice. In fact if you seek anything like 50%, even of the actual profit, she will not look twice.
Of course, if land can be bought at low cost it may be worth paying an overage when, and only when, she herself sees the potential for a substantial increase in value.
Most developers are rational optimists. They will calculate the odds. So they may be prepared to buy land subject to overage, but only if it is worth the risk. To the seller, the overage could be worth far more than his sale price of the land. He will also know that if he is to receive an overage, he has to sell to a developer who is likely to get to work and achieve success. So should he put a 50% figure into the agreement in the off chance that some fool will buy at a good price now but then be so lucky in future as to obtain planning permission for a Trump Tower? No, he will want to sell to the dynamic developer who will double his sale price within a couple of years provided it costs her only 10% of her profit.
On the question of fairness, it will not have escaped your attention that an overage gives the seller has the benefit of inflation on overage interest. He will receive the inflation benefit of a part owner while putting out not one pound of his money or one minute of his time.
A continuing overage is a mortgage killer
I really have trouble getting my head around why any conveyancing solicitor fails to see this problem. About half of a solicitor’s professional regulations are directly concerned with money. Most residential and commercial property is bought with a mortgage. Yet I have never come across a solicitor who “sees” that a continuing overage is a mortgage killer.
It is not just about “How many years?” It is about any years at all. Suppose you were a mortgage lender and someone wants to borrow from you. There is a 25% overage on his house with ten years still to run. Would you lend to him? Of course you would not. You would be worried that if you had to take possession in default, you would not get your money back. We have asked many building societies and banks whether they would lend on an “overaged” house. We have yet to find a single one that will.
Let us go back up the chain: the building society will not lend, so no buyer can buy the new house, so no builder will build a house on that land. So no builder will buy that land. This applies no matter how good the chance of planning permission. By using continuing overage terms, the seller has limited the potential buyers to people who has no intention to build - ever. So his solicitor and land agent have together effectively advised him to sell at half price - or hoped there is some really stupid bidder with more money than sense. Why cannot solicitors see this?
There is a simple way out of this. The seller should encourage the buyer by limiting the overage to the first full bite at the cherry. In other words, if the buyer obtains consent for any named uses, like residential, or supermarket, that is the end of it. The seller gets his yummy payment and everyone is happy.
Use a variable sum overage
It is not generally appreciated that overage terms can be fine tuned - just like any commercial agreement. Examples are:
- conditional - payable only if:
the land value increases by a given sum or percentage;
the land use changes to specified high value uses;
- incentivise -
reduce the overage for any payment due within [two?] years - so as to incentivise the buyer to move fast.
schedule the entire period on a reducing scale
- trigger -
overage agreements are invariably triggered by the grant of planning permission because that grant is the what actually increases the value. However, there is no reason why you should not make a deal whereby the seller was paid a fixed sum per house sold or per sq m of built area. This will certainly increase the sale price because it removes one of the problems for the buyer - funding the cash payment.
- fixed sum -
a fixed sum is payable within a specified period. That gives certainty to both sides and eliminates valuations and arguments completely. In that case, the agreement simply provides for a fixed sum to be paid on the happening of whatever the seller decides. You can easily provide for that sum to be increased with time or fixed by reference to an index.
- different rates for different uses -
Vary the payment or percentage according to whether the consent is for a superstore, flats, or small warehousing.
Do not be fooled by a local authority
To complete this article, I will mention just one more point: assignment of buyer’s rights to receive overage. Most agreements state this right explicitly, but even if unstated, the right would exist. So when a local authority seller answers the issues set out above with the reply that “they” will of course not pursue a house owner who wants a modest extension in ten years’ time, they are being naiive or ignorant. Their estates department will in due course sell a portfolio of overage agreements to a private sector buyer. The first action by the buyer will be to inspect every site / plot / house and come up with a charge to overage for every greenhouse, solar panel and windmill he can find.
Other useful considerations
Estate agents / auctioneers are in the business of selling real estate. They probably get paid less for selling with an overage than without.
In marketing your land, they want to stir up as much interest as possible. They often fail even to mention that there is an overage provisions. That failure is in breach of the Estate Agents Act 1979. (Parts of the Act do not apply to sales by auction). The failure leaves a prospective buyer to spend hours in investigating your land, only to find a delinquent solicitor has sent the draft title documents to the auctioneer three days before the sale. Developers stay away.
Obtaining outline planning permission does not open a chestful of gold. Set the time for payment as six months after the date PP is granted. That way, smaller companies can also join the competition to buy.
Keep the terms as simple as possible. Avoid the requirement for valuations or other scope for disagreement.
Solicitors should use a separate document for the overage deal so as not to confuse it procedurally with any purchase or sale document. Make sure it is drawn in terms which are registrable.
Define the trigger for payment carefully.