This article appeared in the Estates Gazette in 11 July 2011.
One of the starkest, and ongoing, effects of the economic downturn on the property sector has been the creation of a two-tier market. In residential, commercial, leisure or even agricultural space, the flight to quality has seen prime assets rise in value over the past 18 months, while secondary properties have languished stubbornly close to their 2009 lows.
Such a two-tier effect has also established itself within the market for residential development sites. Well-located sites that are suitable for high-end residential development (limited, except in a few cases, to the south-east of England) command values far beyond plots that are suitable for only high-density housing focused towards first-time buyers.
The contracts for such land purchases are usually conditional on planning permission being secured, if not already in place, which typically takes upwards of 18 months. As a result, many developers in 2008 and early 2009 found themselves in a situation where they had entered into contracts that were conditional on obtaining planning permission, having agreed to pay top dollar for a site that was no longer economical to develop.
These situations became common, with developers desperately searching for ways to extricate themselves from their agreements. They used a number of delaying tactics, such as arguing that planning permissions obtained were not satisfactory or trying to avoid obtaining planning by invoking extensions to the contract to delay the time at which payment was required in the hope that values would recover. Another tactic was for work on securing planning permission to grind to a virtual halt.
Of course, the converse was true for sellers with option agreements where prices were linked to open market values. In those circumstances, it was the sellers that tried to prevent planning permission being granted, which would have enabled developers to exercise the option at prices below sellers’ expectations.
So how does the situation look in 2011? The experiences of the past two years and the uncertain future while spending cuts take place has made developers nervous about entering into contracts at prices that may drop by the time planning permission has been obtained.
The nature of the ongoing two-tier market in residential development means that the vast majority of secondary locations are unsold, while prime plots are being sold at prices that sometimes reach pre-credit crunch prices.
At the root of this situation lies the time needed to secure planning permission and the subsequent time before any return can be made. With a fresh site, planning approval takes at least 18 months and construction another year. This means that a developer will not be able to sell its property until two-and-a-half years after it first purchased the land.
As a consequence, developers prefer to enter into option agreements, since this gives them absolute control as to whether they proceed. If such an agreement is not acceptable to the seller, developers will want as much “wriggle room” as possible in their conditional contract.
Some developers look to negotiate the inclusion of a right to rescind after planning permission has been obtained, enabling the developer to reassess the viability at that stage and decide whether it wants to proceed. The benefit for the owner is that it is able to use the plans and drawings contained in the planning permission at no cost.
The contract can also be drafted to give the developer as much flexibility as possible. For example, the definition of what is an acceptable planning permission should contain an acceptable minimum square footage so that, if planning can only be obtained for a smaller area, the developer would be able to rescind.
In addition, the definition of an onerous condition should include a maximum limit for section 106 contributions. If the contributions exceed that amount, the developer can decide whether it wants to proceed.
It is, however, essential that such contracts contain the right to waive the conditions so that even if they are onerous, the developer can proceed notwithstanding such conditions are not satisfied.
In a property market that remains risk-averse, such sites remove a significant amount of the risk faced by developers: housebuilders know exactly where they stand on the planning front, and are also building homes to sell in 12 months’ time. However, as one would expect, these sites command the best prices.
One final point to note is obligations imposed on developers in contracts outlining one party’s responsibility to secure planning approval. With the deal not becoming unconditional until planning consent has been gained, the term “reasonable endeavours” is often used to describe the extent of the developer’s obligations in obtaining permission. The difficulty, or the benefit as the case may be, in defining “reasonable endeavours” is that there is a significant amount of leeway in determining this obligation.
Two other similar phrases are used. It is usual to resist an obligation to use “best endeavours” as this imposes too strong an obligation. However, care should also be taken to try to avoid an obligation to use “all reasonable endeavours” as some cases have held that this obligation can be close to “best” and implies that every reasonable possibility has been exhausted before this obligation is satisfied.
The lesson is simple: for a party to have wriggle room, or stop the opposite party having too much, it is essential to define what is required. Failure to do so could prove costly.