Scotland has a chronic shortage of housing and good land for new homes is in high demand. When potentially developable land comes on the market, developers will be keen to secure a position with the landowner ahead of their competition. The two most common contracts between landowners and developers are contract to buy and option contract. But what is the difference?
Contract to Buy
A contract to buy is, as its name suggests, a contract in which the buyer commits to buying the property. Generally, a developer will enter a conditional contract to buy which means that they will buy the land, only if and when certain conditions are met.
The conditions in a contract to buy a proposed residential site will generally include obtaining planning permission and other statutory consents such as road construction consent for the development and the developer being satisfied with site investigation reports. If any of these conditions have not been met before the 'longstop dates' in the contract, typically around one to two years after the contract is entered into, either the landowner or the developer can terminate the contract and walk away. The contract will generally require the developer to act reasonably in determining whether the conditions have been satisfied (for example, whether a satisfactory planning permission has been issued) and to use reasonable efforts to satisfy the conditions.
Crucially, if the conditions are all satisfied, the developer has to buy the land at either a pre-agreed price or a price calculated in terms of the contract. If it does not, it will be in breach of contract and the landowner may sue for damages or seek a court order to force the developer to buy.
A conditional contract can be beneficial for both parties.
- From a landowner's perspective, it may achieve a price significantly higher than it would achieve in a straight unconditional sale of land without planning permission;
- For a developer, it avoids them having to take the risk of buying a site before it has planning permission in place and locks a landowner into a potential deal with time and opportunity to seek the consents and information it needs to undertake the development.
An option to buy is an agreement in which the landowner gives the developer the option to buy the property either within a certain period or at a specified point in time.
An option tends to be a much longer play for the developer. The land may not have a planning status and will often need to be promoted through the development plan process for it to become available for residential development. The option contract will normally have a mechanism for calculating the price to be paid if and when the option to buy is exercised, usually based on market value at the time of sale. The developer may have to pay a fee to secure the option and/or pay for the landowner's legal costs.
An option agreement is more likely to be used when there is less certainty that planning permission will be secured. It is usually a longer-term arrangement with option periods commonly lasting 10 years or more. Given the time periods involved and the potential expense incurred by the developer, an option is commonly accompanied by a standard security over the land, a charge granted in favour of the developer which will appear on the title to the land. This warns any potential future buyers of the existence of a contract over the land.
The key difference between an option agreement and a conditional contract, is that of developer control. An option agreement will generally give the developer total discretion as to whether or not to buy the land. Even if planning permission is obtained and all other investigations are satisfactorily completed, the developer is under no obligation to buy the land and can walk away if, for example, market conditions have changed and the deal is no longer viable.
Options are attractive to both parties for different reasons:
- For a landowner, an option will generally mean that the developer will finance the costs associated with promoting the land through the planning system to gain residential status and enhance the value of the land.
- For a developer, options are attractive because in return for investment in the planning process, they will be given the first opportunity to buy the land and, in some cases, it will give them a strategic advantage and control over that land.
Which type of contract?
Though in theory, conditional contracts and option agreements are quite different beasts with one obliging the developer to buy and the other giving the developer the choice, in practice, the differences can be minimal. The purchase of the land in both cases is likely to depend on planning permission being obtained with which the developer is satisfied. And, while a contract to buy will oblige the developer to buy the land if the conditions are met, a well-advised developer will have negotiated wriggle room to exit the contract should they wish to do so.
The choice between a contract to buy and an option may come down to the status of the land when the landowner and developer begin their negotiations or the bargaining powers of the parties or the strength of the competition.
So, careful consideration must be given by the developer at heads of terms stage as to the level of commitment it is prepared to give to a potential purchase and the level of control it requires over planning and other matters.