It is hard, if not impossible, for developers to access bank lending to finance the acquisition of development sites. This makes it particularly difficult for those looking at long-term development opportunities.
Historically, option agreements and contracts conditional on planning consent have been the usual means by which developers acquire and put together development sites. This is unlikely to change for sites that have good short-term planning potential and proven pre-let opportunities. But, for sites where a longer-term plan is needed, a promotion agreement can be a way to promote and develop the land over the long term without having to finance the actual purchase, making it a much more viable prospect.
How it works
Take, for example, a developer who identifies a site that has long-term potential for industrial or mixed-use development. Rather than buying it up front, or taking an option to buy once planning is granted, he enters into a promotion agreement with the land owner. A small premium will usually be paid to the owner on completion of the agreement. Thereafter, as with a conditional contract, the agreement will place obligations on the developer to do his best to secure planning consent for the site. Once consent has been granted, the developer will not have to buy the property but instead will market it. Once a sale is completed, the proceeds (less the developer’s costs of securing planning consent and the initial promotion agreement premium paid by the developer) will be shared between developer and land owner in percentages that reflect the value of their contributions.
The promotion agreement can be tailored to fit the requirements of the parties. For example it may require the developer to carry out infrastructure works so as to maximise the market value. The developer may also be granted a right of first refusal to acquire the land (possibly at a discounted rate to open market value) once planning has been granted before it is put on the open market for sale.
The obvious advantage to the developer under a promotion agreement is that his entry costs to the transaction are significantly reduced. He does not have to buy the property but will share in the uplift in value on sale. He will still have to fund the planning costs and expertise to obtain planning permission. From the land owner’s perspective, a promotion agreement can be a more lucrative way of proceeding since the value of the property will be determined by an actual sale rather than a hypothetical market valuation obtained through an option agreement. The property will be sold at full market value rather than at a potential discount, as is often the case under an option agreement.
Promotion agreements are not risk-free for a developer. The fact that he does not buy the land has disadvantages. The only security he has under a promotion agreement is his contract with the land owner. He will need to carefully consider how to protect the significant costs he will incur on any infrastructure works or planning costs. If the land owner defaults, the developer will have contractual remedies but he should probably consider taking further security, such as a legal charge over the land. Also with a promotion agreement a profit share will always be agreed between owner and developer. Therefore, it is likely that the developer will end up giving away more profit than he would otherwise realise had he bought the land following the grant of planning permission under an option or conditional contract. He will need to weigh up the advantages of saving on entry level costs by not having to finance the acquisition of the land against the level of profit he may relinquish at the end of the transaction by entering into a profit share arrangement.
Although development funding is scarce, promotion agreements can offer a relatively inexpensive flexible and innovative way for the smaller developer to realise value and obtain profit from long-term strategic developments.