Property Options: What Are They And How They Can Get You Into The Property Market
Published 10:55 am 18 Jul 2019
Have you seen a property that would make a great development, but don’t have the funds in place to pay for it right now? A Property Option could help you get your foot in the door, writes DG Institute Founder and CEO Dominique Grubisa.
Are you a glass half empty or a glass half full kind of person?
While plenty of would-be developers are throwing their hands up over the current housing downturn, the glass-half-full types are rubbing their hands in delight. While there’s now less potential for rapidly flipping properties to make a capital gain, there are plenty of other opportunities arising. Find out four creative strategies on how you can find out more on how to get into the property market.
One of these is the possibility of taking out Property Options.
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What are property options?
These are legally binding agreements that allow developers to secure the purchase of a property without having to lay down all the money upfront. Under a property option agreement, the vendor and buyer agree to a sale price, the vendor receives an option fee, and, if the deal shapes up, the buyer pays the full price when he or she is ready. If funds for the development can’t be raised or the deal doesn’t stack up, the buyer forfeits the option fee and walks away.
When the market was hot, vendors had their pick of buyers and could often shift their property in a week or two. Now that things have cooled down, they are far more open to creative options around the sale.
Put and call option property
Most Property Options have two phases – the call option property contract, which outlines the buyer’s right to purchase the property within an agreed period of time at an agreed price, and the ‘put option’ where the seller offers the property to the buyer at the agreed price at the end of the agreed period of time. While the option is in operation the seller agrees not to sell the property to a third party.
Property Options can work in favour of both the vendor and the buyer. For vendors, it allows them to achieve a higher market price for their property because option terms are usually around 24 months which means they can negotiate a price that is in keeping with current market trends. For buyers, as well as not having to pay all costs upfront, they can value-add to the property during the term of the option with the view of on-selling it at a higher price.
Before entering into an option to purchase property agreement, it’s always advisable to have a solicitor help draw up the required agreements, and the legal costs for this can vary between $1500-$2000 which should cover the drafting of the option agreement and the contract of sale that goes with it. If you want to save money on this side of the deal, you can contact the relevant land property department in your own State or Territory for a template on what to include in the option agreement.
The biggest cost in a property option agreement is the actual option fee, which can range between three to ten per cent of the property’s market value, although this too can be negotiated with the vendor. Although Government Stamp Duty isn’t usually paid at the time of the initial option agreement, it is payable when the property is purchased at the end of the agreed term. The handling of this does vary from state to state though, so make sure you are aware of the stamp duty consequences before you proceed.
There are risks involved in this type of deal, for both the seller and buyer. For the buyer, it’s important to investigate the property you’re thinking of purchasing. Some vendors may use this type of deal if they’ve had trouble selling their property on the open market. For example, if it’s an older property that needs some work, the vendor may not have the time, capital or even inclination to get it prepared for sale, or it could be a heritage-listed property that has a number of restrictions on it in regards to renovation or refurbishment.
If you’re looking to invest in a parcel of land for future development, it’s important to negotiate and firm up the expectations in regards to that development through the initial contract phase as sometimes the vendor may require you to promote the site for development through a planning process which can be costly and time-intensive.
For vendors, there is the risk that the buyer may pull out of the deal before the end of the contract terms, but they still retain the initial option fee paid at the start of the deal.
Frequently Asked Questions
What are property options?
Property development is a complex process. For a project to be profitable, a developer must bring together the right property with the right investors and the right planning permissions. Sometimes a developer sees a perfect property for development but isn’t sure he will be able to line up finance or obtain the necessary approvals. A property option is a way through which the developer can, with the consent of the owner, protect the property against purchase by other buyers for a period of time by laying down an option fee. The developer then has a right to buy the property down the track, should his deal come together.
How do property options work?
A property option is a legally binding agreement between the owner of a property (the vendor) and an individual or organisation considering buying it (often a developer). The developer and vendor come to an agreement on both the price of the property and a period within which the developer has the right to purchase it. Contracts are exchanged and an option fee, often about one percent of the sale price, is paid to the vendor. If the developer’s deal comes together, he or she buys the property from the vendor within the agreed time frame. If the development falls through, the developer forfeits the option fee and walks away
What is an option contract in real estate?
When a property vendor and a potential buyer agree to enter into an option agreement a contract is generally used to spell out the terms of the agreement. The contract will detail in clear language the names of the parties involved, the agreed purchase price, the option period agreed on, the option fee payable, and whether the option fee forms part of the deposit on the property. The contract also spells out which parties can exercise the option, how exercising the option is to take place, and the completion date for the agreement.
What is a put and call option in real estate?
An option is a contractual arrangement between two parties where one gives the other the exclusive right to deal with the owner’s property within an agreed timeframe. An option to buy a property means that the owner gives a potential buyer the exclusive contractual right to buy the property on pre-agreed terms and conditions. For example, ‘A’ owns a house which ‘B’ would like to buy but only if they can get an adjoining owner ‘C’ to sell their property too. ‘A’ agrees with ‘B’ to sell the property to them at any time within a fixed timeframe at a particular price. This agreement is put in writing and for the privilege of having control over ‘A’s property, ‘B’ pays ‘A’ a sum of money called premium for the right that they have to buy the property. At this point ‘A’ has not sold and ‘B’ has not bought, but ‘B’ has the right but not the commitment or obligation to buy from ‘A’ at all. Meantime, ‘B’ starts their negotiations with ‘C’ with the aim of securing an option from ‘C’ over their property too. While the option period is current neither ‘A’ nor ‘C’ can sell their properties to anyone other than ‘B’. If ‘B’ decides to buy the properties or either of them they can exercise their option by calling on the respective owners to enter into a contract for sale with them at the pre-agreed price. Alternatively, if ‘B’ decides not to proceed they can do nothing and the option, or the right to buy, will expire in time and neither party has any commitment to the other. The price that ‘B’ pays for the privilege of controlling the properties is the premium and if they do not exercise the premium then they forfeit that money to the respective owners.
The popular terminology is a “put and call option” but the procedures are out of context. In the example above, ‘B’ has a call option, meaning that you can call on the other party to sell to them. Put option is an option where the seller calls on the buyer to buy. If ‘B’ entered into a put and call option then if they decided not to proceed then ‘A’ and ‘C’ course call on ‘B’ to buy and they would be obliged to do so.
Put options are particularly dangerous because if ‘B’ decided not to exercise their call option they could be forced to buy. They may have decided not to buy the properties at all because they changed their mind, they could not get finance, the cost of developing the site may have been beyond their expectations so as to become uneconomical. With a call option they can walk away from the deal but with a put option then no matter what ‘A’ and ‘C’ in force ‘B’ to buy and they are legally committed to do so.
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