Property development: constraints and solutions

• United Kingdom

• Real estate

13-02-2019

Eversheds Sutherland property column: February 2019

Despite broad challenges, including Brexit-related uncertainty, interest in property development remains robust. However, development faces a broad set of challenges, among which funding, structuring, planning and legal constraints can be particularly critical. With proper structuring, we are developing and implementing a wide range of strategies for our clients to overcome these challenges and to bring schemes to successful fruition.

Often developments will involve multiple assets, sometimes with social housing and mixed-use components, and multiple investors having different interests and sources of funding. Each investor will be concerned to protect its position throughout the life of the project and particularly in default scenarios where, for example, a development may only be part complete when the default occurs. Structuring these deals correctly at the outset in a manner that anticipates and deals with the necessary interactions between the investors and the various competing interests at play becomes fundamental.

First, the funding. The first considerations will centre around the most suitable legal vehicle and structure to meet the finance needs of the project, given that there are a number of ways to finance a real estate development. Commonly a mixture of equity and debt funding is used in a traditional development finance structure. Where third party funding is not available, alternative structures, such as joint ventures and forward-funding arrangements, can offer a solution, often with higher returns. For example, forward funding enables the developer to remove the upfront costs involved in developing the land and achieve a profit payment on completion of the works, while also saving on marketing, sales and finance charges. The investor benefits from a higher return on investment in return for the risk element that it takes on by funding an as-yet-to-be-built development. With proper structuring at the outset, the investor can also make significant SDLT savings so that SDLT will be payable only on the reduced price payable for the land based on its condition at the date the land is sold, rather than the value of the completed development. Inevitably, with higher returns come higher risks and careful consideration needs to be given to the structuring and documentation of forward funding arrangements to mitigate the potential complications.

Planning constraints are often encountered on development projects and will be another factor that can influence the structure of a deal. Planning consent can take time to obtain and may be subject to judicial review and challenges. The development site may also be subject to planning obligations under section 106 of the Town and Country Planning Act 1990, community infrastructure levy agreements and compulsory purchase orders. In these circumstances, a conditional sale and purchase agreement can be used to allow for purchase of the property once planning consent has been obtained and any other conditions satisfied. Alternatively, options and pre-emption rights can be used where the parties want to put in place a mechanism for purchasing the property in the future once certain milestones have been reached. A land promotion agreement might be used as an alternative. A developer agrees to promote the land for development, to obtain planning permission and to market the property for sale, in return for a fee or a proportion of the net sale proceeds.

Title issues, such as rights of light, access issues and restrictive covenants, can also pose significant constraints on development. Initial legal due diligence is key to ascertaining if there are any third party legal interests which will need to be dealt with. A common title consideration on development projects is the extent to which any rights of light exist. If rights of light are identified, early legal advice should be sought to consider the correct strategy from the outset. These may include negotiating with the parties affected, obtaining rights of light insurance, invoking section 203 of the Housing and Planning Act 2016 to override rights of light, or a combination of these.

Care should be exercised if indemnity insurance is being obtained, as negotiating with the parties affected will invalidate the policy. On the other hand, if section 203 is being relied upon, indemnity insurance may be considered in conjunction with that. The effect of section 203 is to authorise development notwithstanding any interference with any rights of light. The rights will still exist, but will be overridden, preventing the beneficiaries from obtaining an injunction to prevent development. Compensation will be payable to the beneficiaries and, depending on the circumstances, rights of light indemnity insurance should be taken out to cover any residual liability that may arise as a result of reliance on section 203.

Rights of light actions can restrain development even if the development has been granted planning permission. Alternatively, the court can award substantial damages to compensate for the interference with such rights.

Property development is a complex process, often giving rise to a range of legal and other constraints. Given the numerous legal complexities that development can bring through its life cycle, proper structuring of the project and in-depth legal due diligence at the outset are absolutely critical to managing the risks involved.