In a previous blog we talked about "control without ownership." Options are a great way to do this in real estate. Here is a tutorial on how they work.
More on Options – The Right to Buy
A real estate sales contract is a bilateral or two-way agreement. The seller agrees to sell, and the purchaser agrees to buy. Compare this agreement with an option; an option is a unilateral in which the seller is obligated to sell, but the purchaser is not obligated to buy. On the other hand, if the purchaser on a bilateral contract refuses to buy, he can be held liable for damages.
A bilateral contract with contingency is similar to an option. Many contracts contain contingencies, which, if not met, result in the termination of the contract. Essentially, a bilateral contract with a contingency in favor of the purchaser turns a bilateral contract into an option in that it gives the purchaser an out if he decides not to purchase the property.
Though the two are not legally the same, an option and a bilateral purchase contract with a contingency yield the same practical result. The receiver of the option (optionee) typically pays the giver of the option (optionor) some non-refundable option consideration, that is, money or other value for the right to buy.
If the option is exercised, the relationship between the optionor and optionee becomes a binding, bilateral agreement between seller and buyer. In most cases, the option consideration is credited towards the purchase price of the property.
If the option is not exercised, the optionee forfeits his option money. An option can be used to gain control of a property without actually owning it:
- A speculator who is aware of a proposed development can obtain options on farmland and then sell his options to developers.
- To take advantage of appreciation in a hot real estate market, an investor can use a long-term option to purchase property.
- To induce timely rental payments, a landlord can offer the tenant an option to purchase.
There are literally hundreds of ways that an option can be structured and every detail is open for negotiation between the optionor (seller) and optionee (buyer).
An Option Can Be Sold or Exercised
An option, like some real estate purchase agreements, is a personal right that is assignable. If you were able to obtain an option to purchase at favorable terms, you could sell your option. The assignee of the option would then stand in your shoes, having the same right to exercise the option to purchase the property. As with a lease, an option is freely assignable absent an express provision in the option agreement to the contrary.
Alternative to Selling Your Option
Rather than sell your option to purchase, you may wish to exercise the option yourself, then sell the property to a third party buyer. However, in today's market we see most consumers who seek Lease Options doing so as they work to repair their credit and take advantage of a rising market.
The Lease Option
A lease option is really two transactions: a lease and an option to purchase. Under a lease, a tenant may have the option the buy the property. The option itself can be structured in various ways. For example, the option may be that of a right of first refusal in the event the landlord intends to sell the property. The option may also be an exclusive option for the tenant to buy at a certain price. When combined with a lease, a purchase option may also include rent credits, that is, an agreement that part of the monthly rent payments will be applied to reduce the purchase price of the property. There are literally hundreds of ways that an option or lease/option can be structured and every detail is open for negotiation between the landlord and tenant.
Lease Option vs. Lease Purchase
The primary difference between these terms is that a lease option provides you the OPTION to buy, if you so choose. A lease purchase on the other hand commits you to the purchase, however, it is a delayed purchase. For example, a lease purchase might work well for someone who has a large bonus being paid 8 months from now and wants a home but simply needs to delay the close date, while allowing them to take occupancy before closing with a lease.
Options can be valuable tools in the arsenal of creative acquisition techniques for a real estate investor. If you are interested in learning more, please send a private message to HomeLandInvestment@gmail.com
Happy Investing!
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