How to arrange and profit from real estate options

There are several ways to invest in real estate. For many Americans, the most basic real estate investment is in the form of family homes or rental properties. Investing in a single real estate can be a large and lucrative investment with multiple uses. Versatility, long lifespan, and appreciation are usually the primary reasons that make a single real estate investment relatively safe, reliable, and profitable over time.

The rise of online crowdfunding and mortgages has also broadened many possibilities and opportunities for direct real estate investors.Lending Club, Prosper, SoFi, LendingOne, LendingHome, Groundfloor, Money360 and other platforms, And more, Providing a faster, simpler, and more effective way to obtain mortgage loans, increasing the potential for buyers to be more flexible in investment.

With the development of the real estate market, new products are regularly launched. Through these introductions, real estate investors now have a range of choices, including real estate investment groups, real estate mutual funds, real estate investment trusts, and crowdfunding retail products such as Fundrise. However, direct real estate investment still provides a way for investors with an appropriate combination of financial stability and risk tolerance to earn substantial profits. For these investors, real estate options may be a possibility that, when exercised, can increase returns or reduce certain risks of direct real estate investment.

Exchanges do not provide real estate options, they do not fluctuate prices beyond the contract premium, and they usually do not cover multiple units. Real estate options are the most used in the commercial real estate market, but ordinary investors can also use them. Generally, real estate options are used in targeted situations, in which the buyer will benefit from the option, but does not need to purchase the real estate at the end of the holding period.

Key points

  • Real estate options are specially designed contract terms between buyer and seller.
  • The choice of real estate is negotiated between the buyer and the seller and usually provides the buyer with the greatest advantage.
  • Holding term real estate option clauses are the most common, but options with many variations can be drafted.

What are real estate options?

Direct real estate investment has many unique considerations, and these considerations generally do not apply to various other real estate options. For interested or advanced investors, real estate options as contractual terms for direct purchase of real estate may be a potential opportunity. Real estate options have additional complexity and their own unique parameters.

Broadly speaking, real estate options are specially designed contract terms between the buyer and the seller. The seller provides the buyer with the option to purchase the real estate at a fixed price within a specified period of time. The buyer purchases the option to purchase or not to purchase the property at the end of the holding period. For the rights of this option, the buyer pays the option premium to the seller. If the buyer decides to purchase the property (in other words, exercise the real estate option), the seller must sell the property to the buyer in accordance with the terms of the previous contract.

Real Estate and Stock Options

You may have encountered the concept of options when buying stocks. Options provide buyers with some additional options, and their terms are based on the underlying asset. Generally speaking, options can be exercised early, held until the option expires, or may be sold to a second buyer before expiration. Real estate developers and investors often use real estate options in commercial or high-end residential real estate transactions. Real estate options provide buyers with greater flexibility and potentially greater investment opportunities, while sellers have limited returns.

There can be many drafts Real estate options As part of the real estate purchase contract agreement. Some of the most common ones include:

  • Holding period option: The buyer pays a premium for the option to purchase the property, but not required
  • Listing option: Buyers use this option to list properties and may profit from price increases
  • 1031 Exchange option: The buyer pays a premium for the option to obtain the holding period, and then exchanges for similar real estate at the time of purchase

Real estate option premium, negotiated holding period and final selling price are usually the most important part of negotiation in real estate option agreement.

Examples of real estate options

This is a comprehensive analysis of the risks and rewards of real estate options. Suppose a builder has US$500,000 and wants to buy land with a price tag of US$2 million. The builder is not sure about a few things:

  1. Can the builder raise $1.5 million through bank loans or other sources?
  2. Can the builder obtain the necessary permits for residential or commercial development or to further subdivide the property?
  3. Can builders raise funds and obtain permits before other builders buy the land?

In this case, real estate selection is appropriate. For the prescribed non-refundable cost of USD 25,000 (called real estate option premium), the builder can sign a real estate option contract with the seller. The real estate option allows builders to lock in the sale price of real estate at $2 million within six months.

A real estate option contract can include the following conditions:

  • Property details (location, size and other details)
  • Contract period (six months from the date of agreement)
  • Option premium or consideration amount (a one-time non-refundable premium of USD 25,000 paid by the buyer to the seller)
  • If the option is exercised during the contract period, the agreed purchase price (US$2 million)

Possible scenarios

For a six-month contract period, there may be four possible scenarios.

scene one

The builder was approved to obtain a bank loan of US$1.5 million. He also confirmed that he can obtain the necessary development licenses. He exercised his real estate option to purchase the property at a predetermined price of US$2 million. The seller receives US$2 million and retains an additional US$25,000 in option premiums.

Scene two

Two months later, the builder discovered that he would not be able to obtain a development permit. In the next four months, the builder managed to find another party willing to buy the property for $2 million. The builder sold the real estate option to the new party at a new price of $30,000. The new party replaces the builder in the original option contract. The new party exercised the option and purchased the property for US$2 million. The seller received US$2 million from the new party and retained the US$25,000 option premium from the builder. The builder sold the option for $30,000, so he made $5,000 and did not have any unusable property on his back.

Scene 3

Builders are just option buyers who want to benefit from the appreciation of property prices. If the requested price of US$2 million increases to US$2.2 million within five months, the builder will make a profit by exercising the option to purchase the property and selling the property. At the end of the transaction, the owner receives USD 2 million plus an option fee of USD 25,000. The builder made a profit of US$175,000 from the sale of the property.

Scene four

Builders cannot obtain loans or permits. He also couldn’t find any other interested buyers. The builder lets the option expire and loses the premium. However, the buyer paid a premium of US$25,000 (1.25% of the actual transaction value), thereby avoiding a potential investment error of US$2 million. The seller benefits USD 25,000 and continues to look for a buyer.

In all cases, once a real estate option contract is signed, the seller can no longer choose whether to sell the property or at what price during the option holding period. The seller must wait six months to wait for the buyer’s decision. This is why no matter what the buyer ultimately decides, the seller will receive and retain the premium.

special attention items

The holding period of these options may be different, which can also lead to different risks. Sellers are usually locked in a fixed price. However, high-probability exercise can provide them with some time to make better choices or arrangements. Buyers usually need to pay a specific premium during the holding period. The premium may help lower the purchase price. They can also allow buyers to obtain better mortgage financing conditions, thereby reducing overall costs. During the holding period, real estate may also appreciate, but the purchase price remains the same.

Default by option sellers may be one of the main challenges in real estate option agreements. In this case, the buyer’s only recourse is usually litigation. The lack of public information and past records about real estate options participants is another challenge. Real estate option investors may also need to consider additional costs, such as the cost of legal services such as drafting and registering contracts.

Bottom line

Real estate options provide an alternative method of trading, investing, and profiting from real estate investments. They can be regarded as a kind of over-the-counter contract between two parties. These types of options do not have a trading market, but can have creative terms that may allow the buyer to sell the option while still in an active holding period. Generally speaking, the relevant parties must ensure that the terms of the option contract are prepared appropriately, fairly and are complied with by the relevant parties.

Real estate option contracts can provide some alternative ways to make money, but usually one of their biggest advantages is to transfer large risks. Real estate developers can benefit from holding multiple real estate option contracts, and may only exercise a few based on changes in the holding period. If there is a change during the holding period (for example, a new busy highway or an increase in the crime rate), the contract holder can also choose to waive the option.

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