Buying a real estate option? Put every detail in writing
If you mention ''options'' to an investor, an image of puts and calls, highly leveraged securities, and commodity and gold futures comes through loud and clear.
There are, in fact, some similarities between call options and the type of option used in real-estate transactions. In both types of investment, the buyer of the option is buying a promise to sell and not the object itself.
Take, for example, a homeowner who is unable to sell his house on the price and terms desired. Often he may advertise the house for lease with an option to buy. Such a lease is more desirable, all other things being equal, to the renter who hopes to become an owner.
The lease in such a transaction usually provides complete details of the possible purchase transaction, including a time during which the renter can exercise the option to buy. The owner is selling time along with the rental. The renter is buying time, during which he hopes that the value of the house will rise above the usually overvalued option price provided for in the lease.
The option, in short, is a promise to sell, at a fixed price and terms, over a specified time.
Owners of other types of property can often be persuaded to sell options, too. The people who buy options try to do so for a variety of reasons. They may actually be expecting funds at some future date, such as from an inheritance, sale of other property, and the like. They may be ''flippers,'' trying to obtain a promise to sell at a bargain price so that they can resell the property the same day they buy it for more than they paid.
The purchaser of an option may be hedging his bets, knowing that he might need a site for a shopping center or house, but not wanting actually to buy it until the details are worked out. Public agencies often buy options, usually for only nominal amounts, prior to asking official approval of their governing body for the purchase of property for public purposes.
Bargain hunters and entrepreneurs try to buy options for long terms, letting inflation work for them with a minimum of up-front capital. And there may be even more types of investors who buy options.
Who sells options? Often the unwary, some of them persuaded that they are selling their land, when all they are selling is the promise to sell. (It is, of course, fraudulent to sell land that you have already optioned to someone else.)
Inexperienced investors sell options, but fail to obtain enough compensation for tying up their property for the term of the option. Some option sellers are opportunists who have negotiated such a good price for the promise to sell that they don't care if the option is exercised or not.
(When the option term expires and the property is not bought by the option holder, another option may be sold, if a buyer can be found.)
And finally, strategists and negotiators offer to sell an option to make otherwise onerous terms more attractive.
The key to success in buying or selling an option is negotiation of the terms. The premium, or price for the promise to sell, should be high enough to serve the needs of the seller, if the option is not exercised, and low enough to provide flexibility for the buyer, should things not work out.
Thus, the natural tendency is for the seller to want a high premium and the buyer a low premium. The premium should represent some economic substance for both sides.
The term of the option should be negotiated similarly; if the buyer gets more than a six-month option, he has done remarkably well.
The option itself should also speak to the details of the impending future transaction. Who will pay the escrow costs, title insurance, fees, stamps, and liens, if any; what about weed clearing and the like? What if there are title problems? Negotiate all the details when the option is sold, and your problems will be minimized later.
Some people do not like to buy options because they are afraid that the property will be sold to someone else, even during the option period. If a buyer has sufficient reason to distrust the seller that much, maybe there should be no deal. However, any document can be recorded at the county recorder's office, and the option can be recorded, too.
This will prevent transfer of title, assuming that title insurance will be purchased, until the option has expired. This helps protect the option buyer.
If you are trying to buy the option and sell the property to a third party yourself, expect that the purchaser may try to stall your deal just long enough for the option to expire - then approach the owner directly, cutting you out of the deal.
Be prepared to pay up should you suspect this is happening; once you are the owner, the buyer has to deal with you.
That means the option buyer should try to provide for terms of purchase within the option. Set the down payment, the monthly payments, and the interest rate before you buy the option.