Real estate option contract considerations for real estate investors

A real estate option contract allows buyers to gather the funds for purchase within a specific time frame. And there are advantages for sellers, as well

Real estate option contract considerations for real estate investors

For more traditional forms of real estate investment, sellers put properties on the market and consider which buyer offers the best deal.

That basic set up changes, however, when a real estate option contract is introduced.

For starters, the buyer gets exclusive rights to purchase the property, although they are not necessarily obligated to do so. But there is more to a real estate option contract than that.

In this article, we will define exactly what a real estate contract is. We will also break down how it works and explore the options available.

Here is everything you need to know.

What is a real estate option contract?

A real estate option contract is an agreement where the seller offers the buyer an option to purchase the home at a fixed price within a set time frame. It is a uniquely designed agreement that is strictly between the buyer and the seller.

This agreement gives the buyer the exclusive right to buy a specific property for real estate investment. Once a real estate option contract is in place, the seller cannot offer the property to anyone else within the agreed-upon time frame.

The buyer, on the other hand, is under no obligation to buy the property within that agreed-upon time frame. The buyer simply has the option to purchase the property during that period.

The seller must wait until the buyer passes on the purchase or until the contractual time frame is over. If the buyer misses the time frame, the seller can open up the option to other home buyers.

Characteristics of a real estate option contract

At its core, a real estate option contract is simply an agreement between the seller and the buyer. The seller agrees to sell the property for a certain price if the buyer purchases the property within a specific time frame.

Within the contract, real estate options state that the seller is under no obligation to the buyer. Sellers can close the window at any time if no transactions have been initiated on the original agreement. That means the seller has the advantage of a competitive real estate sale package. It also means the buyer benefits from a more competitive deal for their overall purchase.

What is the effect of a real estate option contract?

Real estate option contracts help buyers research crucial details surrounding their purchase. These include environmental impacts, permit needs, and zoning information, among others. They are usually references in large-scale commercial initiatives and property purchases.

Buyers can then reference the information to decide if a purchase price is feasible in the time frame that the seller has set in the real estate option agreement.

Real estate option contract vs. stock options

While often associated with each other, real estate option contracts differ slightly from stock options.

Stock options are like they sound. They give buyers or investors additional choices on a purchase. They can be exercised early, held until option expiry, or even sold to a second buyer prior to expiration.

Real estate contract options are commonly used by property investors and developers in high-end residential or commercial property deals. Real estate contract options provide more flexibility. They also offer a greater investment opportunity for buyers.

How does an option work in real estate

A real estate option is a contract between the seller and the buyer. This contract gives the buyer the option to purchase the property within a specified period for a fixed price. The price stays the same regardless of the market conditions.

Now that we have seen what a real estate option is, let’s look at the other elements involved.

  • optionee: potential buyer of the property
  • optionor: the seller of the property
  • option consideration: also known as earnest money. The option consideration is the payment the buyer gives the seller in exchange for keeping the property off the market for the set time frame.
  • option period: the agreed-upon time frame when the buyer has the option to terminate the contract without losing money. Typically, the option period is between seven and 10 days.
  • exercise of option: The exercise of option is a bilateral contract. The seller is expected to sell the property at a fixed rate. The buyer, meanwhile, is expected to buy the property within a set time frame.

Practical examples of real estate option contracts
To give you a better idea of what options are out there, let’s look at some practical examples of real estate contracts. These options include:

  • Listing option: the buyer may benefit in this case by listing the property and receiving a profit
  • Holding period option: when a buyer pays to have the option to buy the property (but is not obligated to)
  • 1031 exchange option: when the buyer pays to hold onto the property. Then, they can exchange it for a similar property.

What makes these different options so appealing? Property development is one of the most common reasons sellers and buyers pursue real estate options.

Let’s say you own 200 acres of land. You want to sell the land while a potential buyer wants to develop a new subdivision. By pursuing a real estate option, the buyer has more time to secure the funds. You can sell the property to a credible buyer who is lower risk.

Why use an option contract in real estate?

There are many advantages for both buyers and sellers who pursue real estate option contracts. Buyers lock in the price of the property while getting more time to gather funds for purchase. Sellers, on the other hand, can sell to an investor. This is a lower-risk way to sell land for property development.

Let’s look a little more in-depth at the advantages for both buyers and sellers.

Real estate option contract: advantages for buyers

A real estate option contract is great for buyers. If you want to build a new home or lot of land, an option contract can be used to keep the lot available for a certain period. This can be ideal if you still need to gather funding.

The seller cannot sell the land to another buyer during that period. At the end of the term, the seller must sell the land at the price already agreed upon. This is true even if property values have increased in the meantime.

Some option contracts might include terms that put a cap on the price of the property. They may also include other factors to determine the final price.

 A real estate option contract offers advantages to both buyers and sellers.

Real estate option contract: advantages for sellers

For sellers, real estate option contracts can secure a high-profit investment with relatively low risk.

Let’s say, for instance, an investor chooses a plot of land as a prime location for further development for a shopping center or a subdivision. Instead of buying the land and selling it to developers, the investor buys exclusive rights to the land through an option.

The investor then offers developers the land at a much higher price than the locked-in option purchase price. After the higher offer is accepted, the investor can sell the option itself for the purchase price. Otherwise, the investor can purchase the land and flip it to the developer, profiting from the difference.

Key takeaways in real estate option contracts

As we have seen, a real estate option contract offers advantages for both buyers and sellers. For buyers, it is ideal if you want to purchase a lot for a certain price during a set time frame. For sellers, on the other hand, it is a great way to secure a high-profit investment with minimal risk.  

While a basic premise on the surface, there are options within this framework. It is important to know what your options are before you enter into a real estate option contract.

If you want to learn more about real estate option contracts, get in touch with one of the mortgage professionals we highlight in our Best in Mortgage section. Here you will find the top performing mortgage professionals across the USA.

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