Development Agreements: What are they?

If you have ever wondered about the different types of Development Agreements, this update is for you.

Development Agreements, in their various formats, are all about the relationships between property developers, tenants, and property investors, and who takes the risks in relation to a particular deal.  There are numerous competing interests, and no transaction is ever the same. These are some of the most complex documents that developers, tenants and investors will enter into.  

Why do parties need a Development Agreement, and what are they seeking to achieve?  

In essence, their respective roles are:

• A developer constructs (and usually lets) a building and then sells onto a property investor at a profit for the developer
• A tenant secures its occupation of a new building by way of a lease
• A property investor acquires an attractive investment in an income generating property.

Some of the most common types of Development Agreements are:

• Pre-Let Agreement/Agreement for Lease: Two names to describe the same thing. This is possibly the most straightforward version of these types of agreements. In essence this is the way we get to the grant of a lease of a new building. The developer agrees to carry out the construction of the building at the property and the tenant agrees to take a lease of the building once the works have been completed. Once the lease is in place, the developer will usually sell the completed investment to a property investor. No development risks are taken by the tenant.  Similarly, no development risks are taken by the investor purchaser, whose only involvement is to buy the finished investment. The developer must find the property and the tenant and fund the development itself – either from its own funds or via bank finance. The developer retains more risk and expects this to be reflected in its profits for the deal.
• Forward Purchase Agreement: Essentially putting the agreement between the developer and the investor in place before any building works are started.  The investor agrees to buy the property once the works are complete and the lease with the tenant is in place. Usually, the investor is not involved in the financing of the project, funding instead in most cases being provided by a bank loan for the developer. There needs to be a pre-let agreement also in place between the developer and the tenant.  The two agreements are put in place, building works are carried out and completed, the lease with the tenant is completed and then the property is sold to the investor. The investor takes minimal risk, as they are not involved in the funding of the development, and do not have to complete the purchase unless the works and the letting are both completed. The developer retains the risk of funding and carrying out the development and secures its profit at the point of completion of the sale to the investor.
• Forward Funding Agreement: Here the investor completes the purchase of the property immediately, and the developer then carries out the building works.  The funding is provided by the investor, with the developer drawing down the costs of the building works from the investor as the works progress.  Again, a pre-let agreement will also be needed with the tenant – the developer will find and put a pre-let agreement in place with a tenant, before the sale to the investor.  On completion of the building works, the investor itself grants the lease of the completed building to the tenant.  Here much more risk is assumed by the investor, and the pricing will reflect this.
• Speculative Funding Agreement: This is the same sort of agreement as a forward funding agreement, but without a pre-let agreement with a future tenant.  The investor takes on further risk by funding a development for which there is not yet an end user tenant. Again, the pricing will reflect the relative risks of the parties. These types of development agreement tend to be seen less frequently due to the nature of the risks involved to both developer and investor without an end user already identified.
• Development Agreement: An agreement whereby a developer is engaged by a property owner to carry out a development at a property it already owns. Again, less frequently seen, but some owner occupiers prefer to manage their development projects this way.

What clauses need to go in these documents?   

As you can imagine, with agreements of this complexity, each agreement must be drafted on a bespoke basis.  However, similar drafting themes do run through these documents, and we will take a look at these in our article on key provisions in Development Agreements.