In the context of property transactions, an option agreement is an agreement between a potential buyer and the seller of a property. They can be put in place to provide security and commercial benefits for both developers and landowners alike. However, as with most tools, option agreements carry potential risks and need to be drafted carefully, but, when used in the right way, they have the power to improve the value of a transaction and offer flexibility, usually to the buyer.
An option agreement will set out specific terms relating to the transaction. For example, in exchange for an option fee, the seller will give the potential buyer the option to purchase the property up until a set date (called a call option). For an agreed period, the landowner is usually (but not always) prevented from selling the property to anyone else, which gives the developer or investor time to explore the viability of the project before committing to a purchase.
Whilst a potential investor can hold a considerable amount of power in this situation, there are variations of the agreement where the seller can force through a purchase. This is known as a ‘put option’, which means that the seller can ‘put’ the land on the buyer at any given time, normally once planning permission has been secured. At this point, the buyer is obliged to purchase the land. For an investor trying to secure land however, having the option to buy at their sole discretion would be preferable, allowing the opportunity to decide whether they were happy with the development prospects or an obtained planning permission.
For investors, one of the key draws to option agreements is their potential flexibility as the purchase price can be fixed or be linked to market value, for example. While a more complicated option agreement can incur additional legal costs, an investor may be able to negotiate certain deductions from the end purchase price. Where the purchase price is to be calculated by reference to the open market value, for example, an investor may negotiate deductions from the price for items such as planning fees, infrastructure costs, or third-party easements required to facilitate the development. By having an appreciation of what is required on the site, a strong proposal, and a clear understanding of how much things will cost, a developer is more likely to secure a deal which is acceptable and profitable to them.