An overage agreement, sometimes referred to as a provision, is a type of property contract which means a buyer will pay more than the original purchase price when certain conditions are met.
This type of contract is really popular with sellers as it allows them to regain some of the value of their property or land after a sale has been made. Basically, the seller benefits from the upsurge in value of land after a buyer obtains planning permission to build houses or other properties.
Whether you are a seller or buyer, this article will help property professionals and first-time investors understand how overage agreements work, the benefits of this type of contract clause and why you may want to take advantage of them.
We cover:
The relevance of a trigger event
When to include overage clauses
When not to include overage clauses
Positive overage vs negative overage
How is overage calculated
Tips to create an overage agreement
What is an overage agreement?
Overage agreements are also known as uplift or claw back clauses, because they allow a seller to benefit from the uplift in value of their land and ‘claw back’ some of its value after a sale has been made.
The overage agreement is usually triggered by certain events such as planning permission being granted for an area of land, or the development of houses being started.
What are the trigger events?
Trigger events are the circumstances which must occur for an overage agreement to come into effect. They are known as trigger events as they trigger or activate the overage clause.
Common trigger events include:
Planning permission or change of use being granted on a development
Planning permission being implemented
Approved change of use for a building
Demolition and reconstruction of a building
Permitted development rights being granted
Development project beginning
Properties are sold
Selling land to a Special Purpose Vehicle for development
Auction sales where a seller receives an amount over the reserved price
When councils and housing associations sell properties
In complex agreements, it is not always clear what the trigger events for an overage clause are, so it is always best to consult a specialist solicitor when you are unsure about a clause.
When might an overage clause be included in a contract?
Overage clauses are most commonly included in a contract when land is sold that will likely increase in value in the future if certain events happen. In most cases, the trigger event for the clause being bought into action, and the reason for its inclusion, is the granting of planning permission.
So, imagine a developer buys a plot of land from a farmer with well advanced plans to create a new housing estate or plot of houses. Perhaps the developer has already submitted an application for planning permission to the local authority. This would be a good time to consider drawing up an overage agreement with the guidance of a specialist solicitor.
The contractual agreement will also include time limits for the triggering events to be carried out to ensure the buyer is held to account.
Overage clauses are beneficial to sellers as they allow the profits of a sale of land to be maximised. They also benefit sellers by providing a source of income for a landowner after they no longer have other methods of making money from the land they have sold.
These agreements also incentivise the buyer to develop the land quickly because they are aware they have to share profits with the seller.
When might an overage clause not be suitable in a contract?
We’ve demonstrated how overage clauses can be useful in some contracts, however they are not suitable in all situations.
If the probability of the land being developed is low – the cost and time of negotiating the complex payment arrangements offset the payment that will be made
Can be costly for buyers that want to develop land immediately – the potential cost might be too much to bear for a developer that wants to begin development imminently
Can put off future buyers – if the clause restricts the options of potential buyers. Sometimes clauses are in effect for 25 years which is a long time considering that planning permission is unlikely to take more than 5 years to obtain
The percentage in uplift that sellers ask for – if the percentage value sellers ask for is prohibitively high, buyers may not be able to make enough profit to ensure the development is commercially viable
What is positive overage?
This is a type of overage clause where the seller asks the buyer to promise to make an additional payment if and when a future trigger event occurs. The way the payment is calculated and how the trigger will be determined in advance will be written into the contract for both parties sign.
What is negative overage?
In negative overage sellers restrict buyers through a restrictive covenant or ransom strip, which prevents certain types of development or a change a use. The seller then typically requests payment for the covenant or the ransom strip to be removed.
What are the best ways to secure overage?
To ensure overage is secure and the buyer cannot get around it, the seller can place a restriction on the buyer’s title so that the buyer cannot register developments at the Land Registry without the seller’s permission.
For the seller this ensures the buyer enters a deed of covenant which means they must pay the overage - without this, positive overage is not legally binding on the buyer’s successor in title (someone who takes legal ownership of a property from someone else.)
Any restrictions can cause delays on future developments so a buyer should consider excluding remortgages and short-term leases from restrictions.
How is overage calculated?
There are two main methods to calculate overage payments. They can either be paid by fixed amount, calculated via a formula or the market value of the land when the triggering event takes place.
Some arrangements allow costs to be deducted before overage is calculated; this can be a beneficial arrangement for buyers who face substantial costs to develop land and tight margins. A 50% overage, which is common, would ensure the seller received a greater profit margin than the buyer in cases without a cost deduction clause.
Top tips for creating an overage agreement
Some key considerations when creating an overage agreement include:
What the overage time period will be, how long overage restrictions will apply and
what the trigger events will be, so that they are triggered at the most opportune momentHow the overage payments will be calculated
Overage payments can be difficult to enforce – when the buyer chooses not to develop the land in the way was agreed upon in the overage clause
The overage payment calculation is complicated – this is especially true when the use for the land hasn’t been fully determined
Overage provisions can complicate the sale of land – in some cases forcing buyers to pull out of deals they would have otherwise have gone through with if not for the need to share future profits with sellers
Need help perfecting the finer points of overage?
If you’re in the middle of an overage agreement and have hit a sticking point with the other side, you’ll know how complex this legal function can be to navigate.
For personalised advice and guidance with drafting a contract that will meet your needs, get in touch with our legal assessment team today.