Consider the Options
Savvy investors can conserve capital and create leverage through options.
fully understood, properly prepared, and used correctly, real estate
options are an excellent way for knowledgeable investors to conserve
capital, create leverage, and reduce risks. Investors and clients who
may be short on capital may find options a good strategy for
controlling properties with resale profit potential. Investors can
shield their options profits from federal income tax by purchasing real
estate options through self-directed individual retirement accounts.
Investors are advised to use the services of qualified professionals
when buying options through IRAs.
key to being a successful options investor is knowing which properties
to option to create equity without investing exorbitant amounts of time
and money. Only about two out of every 10 properties are potential
options properties. The most profitable properties for real estate
options usually have one of these conditions:
• rezoning potential;
• condemned for code violations;
• cosmetically rundown;
• obsolescent flaws, such as an outdated facade; and
• correctable problems, such as flawed titles or mold that make them non-marketable.
land located in the path of future growth can present opportunities to
profit from options. Savvy investors can use public information on
projected government infrastructure expansion projects, such as road
construction, to plot the path of growth and buy options on vacant land
located in the vicinity.
most profitable options deals usually are created by imaginative
investors. Using local market knowledge, they identify unfulfilled
market needs, find properties that best fill those needs, and put those
properties under option.
strategy is to sell the option to a buyer who has a use for the
property. Selling an options agreement to a third party requires the
assignment of the real estate option agreement and provides an
assignment fee. This strategy eliminates property transaction costs and
avoids any legal recourse that may result from not purchasing the
Buying options on properties
located in emerging commercial areas that can be rezoned for more
profitable uses is another strategy. An investor can buy an option on a
vacant single-family house and then apply to the local zoning authority
to have it rezoned for use as a professional office. Once the rezoning
request is approved, an investor can either resell their option, or
exercise it and buy the property. This strategy can be very profitable
as converting property is much less expensive than acquiring land and
putting up a new building.
often-overlooked strategy is buying options on properties that have
been destroyed by natural or manmade disasters. Astute investors can
search out property owners who have been reimbursed by their insurers
for their losses but have no desire to rebuild. The investor buys a
one- to two-year option to purchase the property at a bargain price and
clears away the rubble. The investor waits until the recovery is well
underway and then resells or exercises the option. This strategy has a
lot of profit potential because of the lack of competition from other
should protect their positions during the option periods by using
well-written real estate option agreements that clearly define the
terms, conditions, and provisions of the agreement, along with the
rights and responsibilities of both parties. Have a board-certified
real estate attorney draw up your option agreements. Option agreements
must include the following provisions:
Include the full amount paid as the option fee and state that it is to
be credited toward the purchase price when the option is exercised. The
amount of the option fee is negotiable and depends upon the length of
the option period and the value of the property. As a general rule,
never pay more than 5 percent of a property's value as an option fee.
State the exact length of the real estate option period by calendar
dates. Try to negotiate six-month to 12-month option periods.
Specify the fixed purchase price of the property under option,
including how the purchase is to be financed. Financial tests are not
Exercise of Option. Outline
exactly how the optionee is to exercise the option to purchase,
including the method for notifying the optioner. Send the optioner an
exercise of option notification letter by certified mail, with a return
Option Period Extension.
State the optionee's right to extend the option period, including the
length and cost of each extension period. Aim to negotiate three-month
to six-month extensions at no more than $500 a month.
Option Agreement Assignment.
Include a clause that gives the optionee the right to assign the option
agreement to a third party. Failure to include an assignment clause
could preclude an investor from reselling the option agreement.
Eminent Domain. Specify
that the optionee will receive full refund of the option fee plus
interest if the property is condemned by eminent domain during the
Right of Entry. Include the optionee's right, upon notifying the optioner, to enter, clean, repair, market, and show the property.
Risk of Loss. Specify
that the optionee is entitled to a full refund of the option fee plus
accrued interest if the property is damaged or destroyed by fire,
storms, and earthquakes during the option period.
Include that the optioner is prohibited against placing any additional
encumbrances, such as mortgages or deed of trust loans, against the
property during the option period.
Title Transfer Documents. State
that a warranty or grant deed and purchase agreement with the notarized
signature of the optioner is held in escrow by a reputable attorney or
title or escrow company, during the option period.
If permitted by a state's recording statute, specify that the optioner
must execute and acknowledge a memorandum of real estate option
agreement suitable for recording in the county's official public
records, where the title to the property under option is recorded.
Recording a memorandum of option gives the public constructive notice
that the property has an option to purchase on it.
real estate options are comparatively low risk, they are not totally
risk-free. Potential risks that investors cannot control include
foreclosure on the property, the property being placed under the
control of a federal bankruptcy court trustee, and having a property
taken as part of a government asset forfeiture lawsuit. As part of the
due diligence, investigate property owners to see if they are involved
in any pending or ongoing litigation that could adversely affect the