Real Estate Option Contract Explained For Investors

by 10 May 2013

What is an Option Contract?

An "option agreement" is a contract  used in real estate investing that gives you the right to purchase a property for an agreed upon price up to a certain time frame. I did some research on this and this is called a “Straight Option”. This kind of creative real estate investing transaction is called a unilateral contract because only the seller is bound by it. An option obligates the seller, but not the buyer. The buyer has the “right” to purchase the property, but does not have to.

How is an Option Contact Used?

A straight option purchase agreement contract is frequently used by developers and buyers of commercial property and high end luxury homes. A builder does not want to purchase raw ground only to find it cannot be built on or that approvals to change zoning or to subdivide the property won’t go through.

By the same token, the builder does not want to pay a lot of money doing feasibility tests only to find out the seller sold the property to someone else. So the builder uses a straight option contract to lock down the property, an important element of which is consideration. The builder gives the seller consideration (usually money) that is frequently non-refundable for the right to tie up the property and lock in a purchase price for a future sale/transfer.

Another way of thinking of consideration is that it is money the buyer pays to the seller to have the right to purchase the property at a later date. I saw option contacts used almost 100% of the time when I a commissioner for my town’s Planning and Zoning board.

Real estate investors will also use straight option contracts to hold on to a property for future appreciation. They know the potential of the area and want to lock in at today’s value. Other investors will get an option and sell the contract to another real estate investor.

Example of Investing Using An Option Contract

For example, one Realtor got options from three owners that included a corner lot. It was in a commercial area, but the buildings were old and rundown. He tied up the properties with the option and then turned around and sold his options to the drug store chain for $500,000 in a growing central Texas town. His consideration was $5,000 to each owner with a $100,000 “buy option” which put some teeth in his proposal. His net profit was around $175,000 after all of the fees, closing costs and transfers of sale.

Real estate investors may find a homeowner who has a property he wants to sell, but is having trouble selling. You know you could sell the property quickly because you know how to market a property and attract buyers or have a buyers list already established. So, you get an option to purchase the property and start marketing it for sale. Why would the seller do this? Because the seller got the price he wanted and you are willing to do all the work to make this real estate deal be profitable for both parties.

The idea here is that an option gives you control of the property without you having to purchase it. It is creative real estate financing! You can make a profit without using any of your money. You can quick-turn a property and make fast investing profits just like when you wholesale a real estate investment.

Important note: Not all homeowners and real estate agents are “familiar” with this investing technique and often time it needs to be “properly” presented to them and communicated in a face-to-face manner.

Elements of a Standard Option Contract

Here are key elements you will always see included in an option contract:

1 -  The Contract must be in writing

As with all contracts, an option must be in writing. A handshake or verbal agreement is not enough. You must have all parties on the title sing the option contract and date it. Be sure to check the title so you know who will need to sign the contract. Who are the individuals involved? Who is the buyer and who is the seller?

 2 - Location of the Property

If the property has an address, write it down. It wouldn’t hurt to also put the parcel identification number in the contract. If it is raw ground, you may also want to put the legal description of the property in addition to the PIN number and notable boundaries.

3 - Consideration

The amount of the consideration will be in the option contract. This is what makes the contract legal, binding contract. Usually the consideration is money, but it can be whatever the buyer and seller agree to. When you are the buyer, you want to pay as little as possible (perhaps as little as $10). But when you are the seller, you will want your tenant/buyer to pay 3 – 5% of the property’s purchase price.

4 - Time Frame

A specified time frame is written into the option contract that gives the buyer a period of time to exercise the option. This time frame will have a date. Anytime up to that date, the buyer may exercise his option. The means that even thought the buyer may have a five-year option; he can exercise it any time before that date. If he decided to purchase the property 6 months into the option, there is nothing stopping him from exercising the option and buying the property.

5 - Purchase Price

In the option contact, it must state the agreed upon purchase price for the deal and purchase agreement contract to be valid.

Option Contracts can be a great investing strategy to add to your arsenal of real estate investing techniques for getting a deal done. Please leave a COMMENT below if you have any questions or thinking about using an option contract on your next real estate investment.