An overage clause a term in a contract for a property transaction that requires the buyer to make an additional payment to the seller if the property's value increases as a result of specific events, such as the buyer obtaining planning permission.
An overage clause can be found in a sale contract, but often they are the subject of a stand-alone legal agreement.
This article examines how an overage agreement works, their mechanics, calculation methods, types, trigger events, duration, impact on property value, risks for landowners, options for property owners, and the importance of professional advice.
How does overage work?
The concept of overage is that it allows sellers to receive additional payments if the property's value increases after sale.
They originated as a result of sellers wanting to benefit from future value increases due to property development. They've further evolved to balance the interests of both buyers and sellers in various property scenarios, from agricultural land sales to commercial transactions.
You might encounter these clauses when selling farmland with development potential, disposing of commercial property in a regenerating area, or selling large residential plots that could be subdivided. They are a type of anti-embarrassment clause.
Main elements
An overage clause has four main elements: the trigger event, uplift in value, the overage period, and the overage percentage.
The trigger event initiates the overage payment, and is usually something identifiable by both parties, such as obtaining planning permission or selling the land or property. The uplift in value is what indicates property's higher market value. The overage period specifies the timeframe for potential payments, while the overage percentage determines the seller's share of the uplift.
As an example: You inherit agricultural land and sell it to a developer. You insist on an overage clause that provides that if planning permission for two or more houses is granted within 15 years, you'll receive 25% of the increase in the value of the land. This arrangement protects your interests while enabling the developer to purchase the land at a lower initial price.
What are the purposes of overage clauses?
An overage clause serves three primary purposes: it protects the sellers' interests (the 'true' value of the land or property), enables buyers to purchase at lower prices (without risk that if the trigger event did not happen, they would not have overpaid), and allows both parties to share in future value increases.
While overage clauses may appear complex, they can benefit both buyers and sellers when structured fairly.
What are the main types of overage clauses?
Overage provisions can be positive or negative.
Positive overage clauses participate in value increases, while negative ones encourage specific actions.
How do positive overage clauses work?
A positive overage clause provides the seller with a share of future profits if the property's value increases.
For example, if you obtain planning permission to construct houses on the agricultural land, a positive clause would have the effect that you might owe the original seller a percentage of the enhanced value.
In other words, this type of clause distributes the uplift in value when a specific event occurs.
Developers and landowners implement positive overage clauses in approximately 80% of agreements.
What are the implications of negative overage clauses?
A negative overage clause requires you to pay if you don't develop the land as agreed.
For instance, if you fail to construct houses within five years of purchasing the land, you might owe the seller a predetermined amount. These clauses often motivate buyers to develop quickly and prevent land banking.
Although less prevalent, appearing in only about 20% of overage agreements, negative clauses can restrict your options if you're uncertain about developing land, but they can offer opportunities if you're prepared to proceed swiftly.
What events trigger overage payments?
Overage clause trigger events can be varied. They can be general, such as the future sale of the land, or they can be specific, such as obtaining a licence for a particular use case.
The most common triggers are obtaining planning permission, selling the property, and developing or changing the property's use.
How does planning permission affect overage?
You'll need to consider several things here: applying for planning permission, receiving approval, valuing the land before and after permission, calculating the increase in value, and determining the overage payment.
The payment might be due when permission is granted, or it might be due when the land (or parts) are sold. Cash flow can be a challenge, so expect earlier payments made before a sale to be lower than comparable payments made after a sale.
Approximately 50% of overage clauses in the UK are triggered by obtaining planning permission.
When does a property sale trigger overage?
The sale of a property might trigger an overage payment. The things to consider are: agreeing on the sale, comparing the sale price to the original value, calculating the increase in value, and determining the overage payment.
Approximately 30% of overage clauses are triggered by property sales.
How do development and change of use affect overage?
Things to consider here include: starting the development or application for change of use, valuing the property before and after the change, calculating the increase in value, and determining the overage payment.
Approximately 20% of overage clauses are triggered by development or change of use.
How are overage payments calculated?
Overage clause payments are usually calculated according to one of two methods: percentage of increased value and fixed sum payments.
It is possible for a further payment to be liable on subsequent events.
What is the percentage of increased value method?
The percentage of increased value method calculates overage amounts as a portion of the property's value increase.
For example, a 25% overage on a value rise from £500,000 to £1,000,000 after obtaining planning permission results in a £125,000 overage payment.
The process involves determining the original value, assessing the value after the trigger event, calculating the uplift, applying the agreed percentage, and finalising the overage amount.
This method offers flexibility, as the payment varies with the property's value increase. However, it may create uncertainty regarding the final amount due.
How do fixed sum payments work?
Fixed sum payments specify a predetermined amount due upon a trigger event. For instance, you might agree to pay a fixed amount of £100,000 when you secure planning permission for residential development. This method provides both parties with certainty about the potential payment.
Fixed sum payments offer simplicity and predictability. You know precisely what you must pay if the trigger event occurs. However, this method may not reflect the actual uplift value, which could benefit or disadvantage either party depending on market conditions.
Approximately 30% of overage agreements use fixed sum payments. They are less common but may be preferred in situations where certainty is more important than potential gains from property value increases.
What is the typical duration of an overage agreement?
An overage agreement remain enforceable between 5 and 30 years, with an average duration of 15 years in the UK. The nature of the property, anticipated development timelines, and local planning policies affect its duration.
For instance, a 5-year agreement suits land in an area designated for near-term development, while a 25-year period links to the gradual development of a large estate.
The duration of an overage agreement indicates how long it affects your property and when you make decisions without considering overage payments.
What characterises short-term agreements?
A short-term overage agreement lasts 5 years or less. Developers and landowners opt for them in areas with near future development potential or for specific, short-term projects.
For example, a 5-year overage period might link to obtaining a grant of planning permission on land in an area designated for near-term development.
About 25% of overage agreements are short-term. These agreements provide buyers more certainty about future costs, but they limit sellers' potential for long-term gains if property values rise significantly after the agreement ends.
What are the implications of long-term agreements?
A long-term overage agreement lasts over 15 years. Parties select them in scenarios with long-term development potential or phased projects. A 25-year overage period, for instance, links to the gradual development of a large estate, allowing the original landowner to benefit from value increases over time.
These agreements make long-term financial obligations and affect future property sales. About 40% of overage agreements are long-term. While they give potential for significant returns, they also tie you to the property's future for an extended period. This complicates your plans if you want to sell or develop the land in ways not originally anticipated (such as a result of new technology such a solar panels).
How do overage clauses impact property value and marketability?
Properties with overage clauses typically sell for 5-15% less than comparable properties without such clauses, depending on the specific terms. This reduction reflects the potential future financial obligations that buyers must consider.
Various types of buyers perceive properties with overage clauses differently. Property developers might view them as an opportunity for long-term gains, while private individuals often regard them as a financial liability.
What risks do overage clauses pose for landowners?
An overage clause in the sale agreement limits your ability to use or develop your property.
It might prevent you from constructing additional structures, modifying the property's use, or taking certain actions without seller approval. These constraints may alter your plans and reduce flexibility.
Sellers often incorporate these restrictions to safeguard their interests in future property value increases.
What financial uncertainties arise from overage clauses?
Overage clauses may result in unforeseen financial obligations. For instance, you could incur a substantial overage payment after unexpectedly receiving planning permission for development. This may disrupt your financial planning and property decisions.
What options exist for property owners with overage clauses?
If your property is subject to an overage clause then you can still sell the property, develop it, negotiate with the overage beneficiary, or seek to remove or modify the clause.
What should be considered when selling property subject to an overage clause?
When selling property subject to an existing overage clause, you need to consider finding buyers willing to take on the overage obligation, the potential impact on purchase price, and strategies for marketing the property effectively. Overage provisions change your property's attractiveness to potential buyers and the sale agreement may need careful negotiation.
Properties with overage clauses take longer to sell than similar properties without such clauses.
To successfully sell your property, disclose the overage provision clearly to potential buyers. Describe its terms and potential financial implications.
How can property owners approach development under an overage clause?
When developing property subject to an overage clause, you need to balance potential profits against overage payments, consider the timing of development, and plan ways for maximising value. For example, you could stage your development to manage overage payments more effectively.
To assess whether development is right for you, consider current market conditions, local planning policies, and your financial capacity. Conduct a comprehensive analysis. Do the possible gains exceed the overage payments? Is it possible to schedule the development to minimise the impact of the clause?
What strategies exist for negotiating overage clauses?
You can negotiate with the party benefiting from the overage clause by buying out the clause, renegotiating its terms, or seeking modifications to suit changed circumstances.
For example, you might agree to a lump sum payment instead of future overage obligations, making a win-win scenario for both parties.
Successful negotiations need you to find common ground. In particular circumstances, you could suggest a reduced overage percentage in exchange for a guaranteed minimum payment. Or you might propose shortening the overage period in return for a higher percentage during that time.
How does professional advice benefit property owners dealing with overage?
While you might be concerned about incurring additional costs, professional advice often saves money and prevents disputes. For example, a solicitor can help you negotiate more favourable overage terms, potentially saving thousands of pounds. An accountant can inform you about tax implications, helping you plan for potential future payments.
Landowners who seek professional advice on overage matters are 70% less likely to encounter disputes or legal challenges related to these clauses.
Frequently asked questions
Can I avoid paying an overage by selling to a family member?
You cannot avoid overage payments if you sell to a family member. Most overage agreements include provisions for sales to connected persons in order to prevent circumvention of the overage obligation.
You should examine your agreement carefully and consult a solicitor before proceeding with any sale.
What happens if the overage beneficiary no longer exists?
If the original overage beneficiary (the person or company who holds the rights to receive payment) no longer exists or has died, the overage rights may have transferred or been inherited.
This situation often occurs when the beneficiary was a company that has been dissolved or an individual who has died.
You'll need to identify the current beneficiary, which may require tracing the rights through company records or wills.
Can overage clauses be challenged in court?
Courts can scrutinise overage clauses under specific circumstances. Successful challenges have occurred based on grounds such as unreasonable restraint of trade or breach of competition law.
For example, in Jarvis Homes Ltd v Freehold Estates Ltd (2000), the court ruled an overage clause unenforceable due to its excessive duration.
However, these legal proceedings are complex and require expert legal advice.
How do overage clauses affect mortgage applications?
Overage clauses can influence mortgage applications. Lenders may view these clauses as potential liabilities, altering loan terms or approval. They may request additional security or impose stricter lending criteria.
When applying for a mortgage on a property with an overage clause, disclose this information upfront and be prepared to provide details of the clause to your lender.