Overage clauses are provisos in property and land sale contracts. They stipulate that a seller will receive extra proceeds of sale at a later date (in addition to the agreed purchase price).
Typically, one or more conditions must be “triggered” that result in an increase in the property and/or land’s asset value. This subsequently gets clawed back by the seller.
Buyers and sellers involve overage provisions in order to mutually benefit from a “win-win” financial outcome if things go to plan.
Buyers (often property developers) involve themselves in projects that may not otherwise happen without incentivising the seller.
The objective is often to acquire the land or property at a lower value and manage the ongoing cashflows of the development more efficiently. Then, at a pre-agreed point, the developer shares in the future value growth with the seller.
Sellers of underdeveloped land often do not have the experience (and/or direct financial resources) to undergo the planning and build processes themselves.
Entering into a legally-binding overage agreement with a competent developer means benefitting from the future uplift with zero financial input.
As long as everything goes to plan, the net proceeds of sale from the land would be higher than a straight sale.
There are various future scenarios that can trigger the overage payment…
Please note that this template is for reference only.
Indeed, with no “one size fits all” overage provision, we strongly urge you to seek qualified legal advice – particularly during the heads of terms stage.
Please also be aware of the numerous overage clause loopholes (and how to avoid them).
Indeed, it often would not make financial sense to involve overage clauses unless the uplift is significant enough for both the buyer and seller to benefit. This usually only occurs following plans to build multiple units or a sizeable space.
Although not always feasible, the developer will usually want to pay overage after tangible value from the project has been realised. This is because property development is such a capital-intensive business. Spreading liabilities to manage cash flow is likely to be a priority.
There is no set time period for the enforcement of overage clauses. Typically, they last for the time up to planning consent or when the development is complete (and all the units are sold).
Much will also depend on the scope of the project and the nature of the event that will trigger the payment.
1 to 3 years is fairly common for small to mid-size developments. However, it’s not uncommon for overage clause provisions to last for anything up to 25 years – particularly with phased or multi-faceted developments.
Successfully drafted overage clauses find the right balance between an industry-benchmark level of profitability for the developer and fair clawback value for the seller.
It’s worth noting that development in itself is a highly complex area with many moving parts, particularly the larger a project gets.
Broadly speaking, most developers work on what the industry terms a “residual” basis.
This essentially deducts the total cost of executing the project from the expected Gross Development Value (GDV) – i.e. the total sales value of all the units.
For example, let’s take a development project containing 5 houses. The developer expects each house to sell for £200,000, giving a total GDV of £1,000,000.
The research (due diligence) process establishes that total construction costs are likely to be in the region of £600,000. Developers would expect to achieve an industry-standard profit margin of 20% or £200,000 on the project. This leaves a remainder of £200,000 which would, theoretically, go to the land seller.
In terms of an overage agreement, the developer may offer – for instance – £100,000 (50%) initially and the other £150,000 after the trigger event.
Although the developer has to accept a £50,000 hit on the profit, the initial “saving” means that they can manage their cash flow better.
These calculations are, of course, very crude and there are other metrics – such as Internal Rate of Return (IRR) – that often will get introduced into the discussions.
Developers will also pay close attention to a range of “micro” factors such as taxation, overheads, meeting Section 106 and other infrastructure obligations.
Macro considerations (and risks) such as inflation and the range of influences that affect the house sales market must also be considered.
Other times, more complex calculations are necessary where:
These options would often require the seller to have full access to the income and expenditure accounts and engage in regular auditing – which many developers would not be comfortable with.
In our view, any kind of revenue-based overage agreement is risky. Although it’s possible to put caps in place, the seller has less overall control. Questions and concerns could also appear with regards to cost validity and overrun risks.
In short, giving the developer free reign over the project outcome could tip the balance out of the seller’s favour.
With longer time periods, factors such as capital appreciation need to be taken on board.
Sellers can and should expect an inflation-tracked return. This is most appropriate, for instance, where an overage payment will be returned much further down the line.
For these reasons, much of the negotiation process needs to involve discussions on the present value of the land (with and without planning consent) followed by the end value of the development (GDV).
Before agreeing to the structure of the overage agreement, the developer will consult with architects, surveyors, planning consultants and other industry professionals to assess project viability. Sellers can and should be privy to these conversations.
A quantity surveyor / building cost consultant, for example, can apply inflation-index and various stress or scenario testing models. They can also advise on appropriate contingency levels and other exit strategies for the project.
Crucially, there will need to be a clear agreement on the financial realities. The execution of the development needs to maximise returns for both parties. As a seller, remember to ask as many questions as you need to get to this point.
Sellers sometimes agree to a “planning gain” overage transaction.
This is where the developer seeks out planning consent on the land. The “shovel ready” project is then marketed and sold on to another developer or construction company to carry out. Both parties then agree on the future profit share.
Although the overage price will be lower, the seller avoids much of the development risk (which almost always involves a fair dose of stress and hassle all round). For the seller, it also means that payment happens in a shorter space of time.
Initially, much of the process will be similar to what’s described above. No buyer / developer, after all, will be interested in an unviable project.
Reasonable expectations should be set for how much profit there is after accounting for planning and various procedural costs. Essentially, there needs to be enough margin for a future developer to take the project on.
The most successful partnerships happen when the planning consent applicant has good a understanding of the intricacies involved.
Assuming consent is in place, sellers should also seek out pre and post permission land valuations by a RICS surveyor.
Be sure to also confirm whether the consent is full, outline or for Permitted Development Rights. Each has its own implications on project execution.
Also, check for any enforceable “reserved matters” – i.e. conditions that may prevent the start of the project.
With every overage agreement varying in terms of scope, sellers need to be mindful of a range of scenarios that could put any future payment in jeopardy.
Examples of broader scenarios that disfavour the seller include:
For these reasons, always consult an experienced solicitor. Remember – in the face of badly drafted overage agreements / clauses – the future litigation costs will be huge.
Obtaining a guarantee or good faith clauses that set a minimum amount of overage before termination of the agreement (or the payment can be secured againt future phases of the development or other assets).
A good contract lawyer can explore all the angles and potential exit loopholes whilst also including “anti-embarrassment” clauses throughout.
Note the role of solicitors is not to advise on whether the overage payment is fair – but to ensure their clients are protected in the eyes of the law.
Whilst the buyer can offer to cover the legal fees involved, sellers should check what the appointed solicitor can and can’t advise on.
Say overage clause discussions extend over the original expected times, the seller could be liable for extra transactional (conveyancing) fees.
Indeed, it can often make sense to seek a second pair of legal eyes to review the heads of terms and other related documentation before signing.
Although often not explicitly stated in the legal documentation, it’s worth noting the difference between positive and negative overage clauses.
The most common type of overage is where the seller contractually obliges the buyer to make a further payment if/when the trigger event occurs.
As discussed below, the most common overage is a legal restriction (RX1) on any future disposal to a different party. The seller becomes the beneficiary and requires full consent before any disposal can happen. Removal of the restriction can only happen after receipt of the overage payment (and any associated obligations).
If the restriction on title is not properly placed over the land (by way of a positive covenant), the buyer may not be tied into the terms of the overage.
The seller places specific control over the land or property asset which prevents sale without satisfying the terms of the overage clause.
Note that sometimes there may be a combination of the above as clauses within the overage agreement.
Securing the seller’s financial interest in the project is possible in a number of ways…
Assuming there is sufficient equity, a first legal charge is one of the best ways to protect any financial interest.
With the right legal mechanisms in place, the seller can take back possession or force the land sale (through auction, for example) to claim back the land value alongside additional compensation.
One issue here is the potential conflict as the developer’s creditors and partners would also want the first charge over the asset. They’re also likely to be concerned about overall profitability and security.
Much will therefore come down to the project’s financial viability. Lenders and investors that agree to go ahead will often place premiums and other risk mitigation measures to protect their interests.
Another option could be for the seller secures the first charge up until the commencement of the project, after which the developer makes the overage payment. The lender then takes over after this point.
Alternatively, the lender may be able to take the charge over other assets owned by the developer.
Where the seller’s property or land is transferred into a Special Purpose Vehicle (i.e. a separate Limited company), the trigger can be when control of the company changes or after a certain amount of shares are sold off.
Note that in such scenarios, Land Registry restrictions will not prevent the sale of shares and the developer could potentially work around this issue.
Also, undertaking the transaction through a Special Purpose Vehicle (SPV) means there will be no external assets to pursue.
As the freehold owner, it’s possible to grant a lease and retain the freehold rather than sell.
The overage effectively then becomes a covenant (legal commitment) that binds the buyer (and leaseholder).
The seller can retain some kind of ransom strip.
This is usually a small piece of land integral to the development as a whole. The transfer of the strip will go back to the developer (landowner) upon payment of the overage.
Note that complexities could arise if there are multiple overage triggers. Also, prescriptive rights could also develop over time (which could limit the legal enforceability of the ransom strip).
In such cases, there should be a clearly defined overage payment agreement to accompany the ransom strip.
Restrictive covenants are essentially constraints on what can be done with the plot of land. They are legally watertight and often cheaper to draft.
One example could be a green belt plot of land with a restrictive covenant imposed on it for solely agricultural use until planning consent is granted. The release of the covenant only happens after the overage payment.
However, some lawyers argue that restrictive covenants for overage purposes are legally tenuous. There has also been case law that has rendered them unenforceable in recent history.
Restrictive covenants cannot also include overage calculations meaning that the end payment could end being open to dispute.
Most developers are happy for a legal restriction to be in place.
This provides them without constraints to execute the project. There is no risk of the seller losing the right to receive a future overage payment.
Clear satisfaction of the terms of the agreement is the best way to remove the overage clause.
However, as a buyer, you may come across a plot of land or property that has an underlying or latent overage obligation.
Assuming the overage agreement was drafted correctly, it is always the beneficiary (the seller) that will consent to removal.
For this reason, the options are:
A conveyancer undertakes this process with any restriction formally removed at the HM Land Registry.
For sellers, much will depend on how the land is owned. If comes as part of a property (on the same title) that has been lived in as a Principal Private Residence (PPR), there would no tax due.
Inherited land or property owned in a limited company, will have specific tax-related implications. Note that if the property being sold has commercial elements, VAT will be due on the sale price and the overage amount.
The buyer will pay Stamp Duty Land Tax on the purchase price. This tax is also due on the enhanced value of the land if the overage is triggered. There may be deferments available.
We strongly advise seeking suitably qualified tax advice in good time before proceeding with any kind of overage transaction.