Is Real Estate Options a Good Tool?

[Nathan Ryder]

As a new investor I am trying to fill my "Toolbox" to close as many deals that come to me. I have come across many ways to invest. I have learned wholesale so far, but would like to have another option for those that this will not work for. I would like to hear some opinions and statistics about using Real Estate Options. I appreciate any and all information about Real Estate Options from those that know best.

[Bill Gulley]

Okay, I was mentioned and I'll drill down a little deeper.

What Brian has outlined are arrangements that could be made they are not really types of options, but he has elected to give names to various ideas. In residential RE, an option contract may be made as a stand alone agreement or made in connection with other agreements. In NO situation, should an option be included in one document with a lease, any lease-option arrangement should be under seperate agreements. We have covered this issue on BP before and the problems that ultimately arise with financing when a lease and an option are under one cover.

If an Option Price is more than sufficient for a down payment for a financed purchase, the concerns of having two seperate agreements deminishes. But using two seperate contracts always works and using a contract that incorporates a lease and an option only in limited situations simply is nothing more than a seperate product to be marketed, it serves no unique function that would not be accomplished with two agreements.

You need to begin at the beginning to understand concepts used to buy, use or control a property.

An "Option" is nothing more than a contract, an agreement, given by an Optionor (owner) to an Optionee (a buyer or tenant or other entity) that restricts the rights of ownership held by the Optionor and grants the Optionee rights to some future benefit to buy, lease or use a property.

You may have an option to purchase a property, you can have the option to renew a lease or the option to mineral rights, plant trees and retain the fruits grown or to obtain any other lawful use of a property.

An Option on real estate must comply with the Statute of Frauds, be a written agreement, it must be signed by the grantor/optionor and it must contain all of the requirements of a contract to be enforceable.

The parties to the contract must be named, the legal description of the subject property must be given and the contract must meet the legal requirements fo a valid contract.

Sufficient consideration must be paid for a valid contract. An Option Price must be paid to have a valide Option. While "sufficient consideration" may be rather creative, the consideration must be able to be valued in dollars. I could say "For and in consideration of Ten Dollars and the love and affection of my children" which is acceptable in our society and courts, consideration between unrelated parties must be valuable enough for the transaction contemplated. Ten per cent of the purchase price for the property is accepted as sufficient consideration for an Option.

An Option must be for a stated term in time, an Option can not be forever there must be a termination date. The longer the Option term, the more valuable it is. So, a term of 6 months may have sufficient consideration paid with a few hundred dollars, a three year agreement is much more valuable and a 5, 10 or 20 year agreement can require amounts needed to be paid that the transaction becomes a financing arrangement. Again, a ten per cent Option Price is generally accepted in small real estate transactions for a term of less than five years. Option contracts are valued under the concept of the time value of money as the purcahse price agreed to is being paid in the future. The value is also impacted by other related agrrements, if the Optionor is granting other uses of the property over the Option term.

An Option must contain a stated sale price to be paid if the Optionee elects to exercise the rights to purchase. The sale price must be determinable at the time the Option is given. Saying the price is $120,000 with six per cent per anum at a per diem rate to the date the option is taken is determinable. From that we can determine the price to be paid in 6 months or 3 years in the future. I mention this as an example as a determinable sale price, it might be applicable for a short term agreement but such an arrangement will likely be seen as a financing arrangement over a longer term as well. That is a caution to the creative minds out there.

As opposed to a sale contract where both parties are obligated to perform, an Option is, at the election of the Optionee, they are not obligated to perfom any function or act.

A contract that is contingent on performance of the optionee is not a true Option Contract. While placing any contingency or requirement on an optionee, such as successfully completing a lease, is not an Option but a contract arrangement to sell under agreed terms. Some use a contract that requires the Optionee to perform over a term but it does not become an option until requirements have been met by the buyer or optionee. As such agreements may be lawful, giving the buyer or optionee the percetion that they have the option to purchase as a true Option may present problems as it is possible for a buyer to acquire cash to purchase prior to the requirements being met. While an Optionor may not object to the sale, depending on how the agreement was constructed they may not have a valid agreement. At that point, a new purchase contract might be required.

Financing an Option Price may be accomplished by the Optionee making a note for the consideration and the Option Price is considered to be paid under the terms of the note. So long as the note is not in default, consideration has been exchanged, the note for the Option, in the event the note is in default then consideration is not being paid as required. However, just as mentioned, such an agreement is more of an installment option, a financing arrangement and if done with and agreement giving possession, it may carry the same force and effect as a contract for deed being a financed purchase agreement.

Another issue is that many talk about using an Option to lock up a property thinking it can't be sold. Actually, an Option is a deed restriction, a contingency that the title holder may be obligated to sell. A property with an outstanding open option can be sold to another party at any time over the option term, but is sold with the option in force. Those wondering about title insurance requirements, the property is sold with the cloud on title and is excepted from coverage, similar to a Sub-to transaction with existing liens.

Such an arrangement or transaction can be accomplished where you take an Option to buy a property from a seller within one year for $100,000. The seller needs to sell and agrees to take $90,000 if it can be sold within 45 days and the seller gives the Optionee the first right of refusal to exercise the option, but the Optionee can't perform. I come along anf agree to purchase the property subject to the open option. The seller sells to me at $90,000 and I take title. If the Optionee elects to exercise the option, I'm then obligated to sell at $100,000. Yes, I make $10,000 less my expenses.

Since investors dealing in options have seemed to be under this umbrella of protection I know they have missed this alternative to apply in certain circumstances. When a "Notice of Option" is filed for record, it clouds title, it does not prevent title from passing. It will generally prevent any lender from getting involved and it certainly limits most buyers from considering a purchase knowing they might be required to sell over the term. So, while we say "tie-up" it's a lose noose. An example of why I always suggest that investors begin with the basics rather than guru strategies and relying on "Forum Colleges of RE". :)

I know all of this is boring, it lacks the bullet points of schemes and methods to employ various option situations that many perfer to see.

Before getting creative in doing Options you really need to be familiar with RE law, contracting requirements as well as local custom. There are certain strategies promoted by mentors, coaches, gurus and even attorneys that may spin or modify basic transactions. Giving names to variations of a basic transaction may make them identifiable and therefore marketable, often the zebra loses his stripes and loses the basic concept and becomes another animal that can be subject to unintended consequences. :)