One of the best things about options is that you can control hundreds of thousands of dollars worth of real estate for less than $100 – and control it for decades. No other document in real estate is this powerful!
You can use options to buy, sell or just park a property. For homeowners, selling an option is often much safer than borrowing money and securing the note against the property. Options can be used to secure your interest in a partnership deal. You can even use an option to control a property after you’ve sold it. And here’s a good one: When we’re making a self-directed Roth investment, we usually use options to secure our interests. This list goes on and on!
One of the questions we’re regularly asked is: What can an investor do once he owns an option? This is where things really get interesting. The investor can hold an option and exercise it in the future. An option can be sold or traded. Did you know that you can be paid for cancelling an option?
Here’s an example of a particular type of option we use regularly when selling a property. A few years back, we were selling a property. One of the terms of sale was that the buyer would give us a ten year First Right of Refusal Option. This means that any time in the next ten years, if the new owner decides to sell, whatever agreement he makes with his buyer, he first has to bring that offer to us. At that time, we have the right to step into his buyer’s shoes.
Shortly after selling the property and getting this First Right of Refusal Option, we sold the option for $2,000 to the man who lived next door to this property. The man wanted the house but couldn’t afford it right then. By buying our option, it gave him an opportunity to buy the home someday down the road.
Now let’s look at a type of option that most folks are familiar with – lease options. Lease options are best structured using two documents – a lease contract and an option contract. The lease outlines the agreement between the landlord and tenant regarding the use of the rented property. The option outlines the agreement between the property owner (usually the landlord) and the tenant regarding the tenant’s right to buy the property.
There is a big difference between a lease purchase and a lease option. With a lease purchase, the tenant is saying he WILL buy the property. With a lease option, the tenant is saying he MAY buy the property. A lease option locks the property owner into selling the property according to the agreed-to terms and conditions outlined in the option agreement. On the other hand, the tenant can exercise his option and buy the property, or he can simply walk away. For most buyers, if their goal is to buy the property in the future, a lease option is the better, safer way to go.
Why would a property owner ever agree to a lease option? There are several reasons: 1) Using lease options often attracts a better caliber of tenant – one who thinks more like a homeowner. 2) Instead of getting a $700 fully-refundable security deposit, the landlord gets a non-refundable option fee, which range anywhere from several hundred to tens of thousands of dollars. 3) The owner is able to lock in a fair-market price while also getting favorable sale terms.
Now let’s talk about straight options. Over the years, Kim and I have used straight options to build future potential wealth. A straight option is a contract in which a property owner agrees to sell you his property at a pre-agreed-to price and terms within a certain time period.
Here’s an example of one of our straight option deals. In 2012, when real estate values were still in the tank, we met a homeowner who needed to make some repairs to his house but couldn’t afford to pay for them. At that time, his home was worth $135,000. The repair estimate was $3,500. His loan balance was $130,000.
We paid him a $3,500 option fee (that would be applied to the sale price if we exercised our option) and in return he sold us an option that would allow us to buy his property anytime within the next ten years for $135,000.
Was this a win-win deal? The owner got $3,500 and was able to make the needed repairs to his home. This wasn’t loaned money that he needed to pay back – it was money he received for selling us an option. In addition, he thought the $135,000 sale price was more than fair because he felt real estate values would continue dropping in the foreseeable future.
On the other side of the coin, we thought real estate values were near the bottom and within the next ten years fair market values would climb steadily. Today, that house is worth $180,000. If we were to exercise our option today, the yearly yield on our $3,500 investment would be 66%. That’s a lot better return than we can get at the bank!