A real estate option agreement is a legal agreement between a seller and a buyer or investor that allows the buyer the right to purchase a property. It usually defines a specific timeframe for the buyer to make their decision to purchase the property or not. If the option is exercised, a closing is held and the property is purchased at the price previously agreed upon. There is no legal obligation to buy the property, but, if the buyer or optionee does not exercise the option, the deposit paid to the seller is forfeited by the buyer.
The biggest differences between having an option agreement as opposed to direct ownership may be two advantages from the standpoint of the buyer:
First, a short-term option agreement of six to twenty-four months can be an excellent way to control a property without assuming the responsibilities of ownership.
Second, the agreement allows a buyer to receive all of the benefits from appreciation in market value of the property during the time the option agreement is in place.
Elimination of Basic Responsibilities
There are five basic responsibilities of property ownership that are eliminated by using an option agreement:
Long-term Commitment. With many investments, there will be no cash profit from property ownership until the property is sold. With an option agreement, the responsibility for a long-term commitment of ownership is eliminated. The buyer or optionee’s commitment is short-term only, with the ability to sell the option, buy and immediately sell the property, or never buy the property.
Mortgage Payments. There are no mortgage payments made by the buyer or optionee. They have eliminated the responsibility to “pay for” the property during the period when the option agreement is open and unexercised.
Property Management. There will be no responsibility with respect to managing and maintaining the property unless the optionee exercises the option and takes possession of the property. In a outright purchase, the buyer must begin maintaining and managing the property right after closing, which is often a time consuming and costly responsibility.
Cash Payments Required. As we all know, property ownership involves payment in full or cash down payment of 10% to 25% or more. When the property is controlled with the option to purchase, the down payment is replaced by an option deposit (the consideration in the agreement), that can be in a much smaller amount, perhaps in the 1% to 5% range.
Financial Liability. A potential buyer or optionee has no financial risk in the property other than the amount paid in the option contract. The property owner must pay the property taxes, mortgage payments, insurance payments, maintenance and repairs and any other obligations of ownership.
The optionee has the specified time period which is the term of the option in for the optionee to decide to buy the property or to pass. During that time, the optionee can evaluate the potential and make those decisions. It is certainly the best way to hold a property for an increase in value over a very short term.
Option Agreements for Property Control
Most real estate investors are attracted to commercial real estate opportunities and typically these investors have been well rewarded for their investment. Properties that are designed for “doing business” succeed as businesses grow and become more profitable. For a real estate investor to be successful it is important for them to understand the operation of the particular commercial enterprise involved in the real estate investment.
However, some investors look for short-term investments with less of an emphasis on “doing business” and more pre-investment research on controlling property for the maximum gain in the short term. These investors often use an option agreement as a tool to accomplish this goal.