Development agreement with option element—lower risk in large projects

The development of large areas often involves high financial risk. A development agreement with an option element can be a smart solution when you want to realise a project without tying up unnecessary capital. This model can offer enhanced financial returns for both the developer and the landowner, provided that the risk is distributed appropriately.

So, what aspects should you pay particular attention to?

Financing: A key factor in large- scale development projects

Large-scale development projects usually require substantial equity and robust liquidity. In central areas and in a stable market, the purchase of the entire development area can be financed through loans.

In more uncertain markets, or in less centralised areas, financing can present a greater challenge. In such cases, the traditional purchase model may involve too high a risk for the developer.

Shared risk provides greater room for manoeuvre

In such cases, an option-based arrangement can be a good alternative. The developer has the right, but not an obligation, to undertake the development. Concurrently, the financial settlement is deferred until the plots have actually been sold and paid for.

The prerequisite is that both parties accept a certain level of risk:

• The developer is able to reduce capital commitment and financial exposure.
• The landowner accepts that the settlement will be executed at a later date, in accordance with the advancement of the project.

If structured correctly, this can lead to a better end result for both parties.

What factors are key in a development agreement with an option?

When it comes to such agreements, there are several factors that should be given due consideration:

• The option enables the developer to commercialise the area according to their own terms. Should there be an absence of regulation, burdensome sequence requirements or a declining market, this could result in the option not being exercised.
• Time limits are of the essence for the landowner. It is generally recommended that the duration of the option be restricted to a period of between two and three years. Following this, the landowner's ability to exit the agreement is primarily governed by the default rules.
• Mortgage and financing: When a developer finances infrastructure on the landowner's property with a loan, the bank will often require a third-party mortgage. In such a scenario, the landowner must ensure that they are entitled to correct settlement in the event of bankruptcy or the realisation of the mortgage.
• Equity and risk: The question is who actually provides the equity: the developer through guarantees and equity, or the landowner through the value of the property. Reduced equity requirements for the developer could potentially lead to increased payments to the landowner, as well as heightened risk.

It is crucial that these risk elements are explicitly regulated in the agreement.

Development agreement with option is an effective tool when you want to reduce your risk

A development agreement with option can be an effective tool when you want to develop larger areas without taking unnecessary risks. With the right balance between option, financing and risk distribution, the model can provide increased value for both the developer and the landowner.

If you would like to know how this could be implemented in your project? Please do not hesitate to get in touch with one of our experts.