PORTFOLIO POINT: Investors can make quick money out of property options with a limited outlay, but knowing the pitfalls will make the whole process much easier.
These days, getting finance can be one of the most challenging components of a property deal. Property options can be a viable way of securing an opportunity, making a healthy profit and moving on – all without splashing out large amounts of cash.
There are two types of options: call options and put options. For the purpose of this article, I’ll only be looking at the first one.
How do call options work?
Call options gives you the right, but not the obligation, to buy something. Instead of going away to save the money and potentially missing out altogether, you put down a small amount to secure your right to purchase a property at a nominated price and within a certain period of time. After signing a document of agreement with the seller, you’re on your way.
In the case of property, there’s generally no maximum timeframe on the exclusive right (but not obligation) to buy. The minimum deposit – or option fee, as it’s called – is just $1.
The document you sign is a legal agreement between you (the grantee) and the owner (grantor). The agreement stipulates that the option holder – the grantee or someone they nominate – obtains the exclusive right to buy the property at a fixed price within an agreed time.
There are various reasons why someone might take an option on a property. The types of deals that involve an option might include townhouse or unit developments, house-and-land packages or rent-to-buy arrangements.
The benefits of options
There are a number of reasons for going down the options route, and numerous potential benefits for the investor driving the deal. Here are the top perks of a property option.
- Interest free for the life of the option: The costs quickly add up on conventional property loans, but with an option there are no interest costs.
- No job or finance necessary: Getting finance can be tricky when it comes to property deals these days. Taking out an option has no financial constraints.
- Minimum risk, no obligation: An option gives you the option to pull out if circumstances change. That flexibility isn’t usually available in a traditional setting.
- Control the property: An option also gives you control of the property and with the owner’s written consent you can apply for development approvals or planning permits through council. You might even choose to undertake a quick cosmetic renovation on the property and sell it on at a higher price.
- Keep the upside: If you add value to the property and sell it on at a higher price than you agreed to pay, you’ve got the right to keep the profit. If the property price falls, you can walk away from the arrangement and not lose out.
- Greater certainty: An option allows you to know your exact financial figures for the life of the deal. You’re not subject to interest rate or lending cost increases. You haven’t technically bought anything, and you haven’t borrowed a bundle of cash.
- No holding costs: Given you haven’t really bought anything and the property hasn’t been transferred into your name, there’s also no financial burden from taxes or council rates.
- Picking an entity: Option agreements can have flexibility and usually include a ‘nominee provision’ that allows you to nominate an entity to exercise the option and buy the property.
How to make money
You might take an option on a property for one price and sell it on as is for a higher value, pocketing the profit without having actually spent any of your own money. There are obviously difficulties involved with this tactic.
You might opt to sell it on with a house-and-land package attached, making money on the build as well as the land.
If there’s already a dwelling on the site, you could renovate it to increase its value and then sell it on for more than the agreed option price.
Or, if the market allows it, you could negotiate an extended period and ride the capital growth wave.
I’ve broken down the usual process and timeline of two of the more common options arrangements below – the house-and-land package option and the raw development site option.
The Dos of options
When you’re undertaking an options arrangement there are some things that you should definitely do.
- Pay a small options fee, if you’re able to – say, $100 or $1000 dollars – to secure the deal. Keep in mind that if you back out, you’ll lose this.
- Enlist a good lawyer to help you and make sure they’re one that understands how options work and what’s involved.
- Start on a small scale so you can get your head around how options work, the potential involved and the many ins and outs.
- Have a clear exit strategy if things don’t go to plan.
- Have a buyer type in mind from the outset and look for agents or marketing groups that can sell your property.
- Do your due diligence on whether the opportunity stacks up. Just because you’ve got something under option doesn’t mean it’s a solid deal.
- Add value to the property where you can.
- When you’re drawing up the paperwork, ensure as the option holder that you’ve got a right to caveat clause to protect your interests. A caveat is like a padlock on a property and will prevent the owner from selling it to someone else.
- Check the owner is up to date with their mortgage repayments. While you might not be liable for their debt, the options agreement is with them – if they default on their commitments and the bank repossesses the property, all bets could be off.
- Consider making monthly options payments – for example, $500 per month – that are non-refundable. This is often a good approach as it allows you to tie up the property as well as find a buyer.
The Don’ts of options
Like any investment, there are a number of things you should avoid doing. The stakes are different when it comes to options.
- Avoid cutting corners when it comes to the agreement. Seek expert advice from someone who knows what they’re doing.
- Invest an adequate amount of money in legal fees. Trying to save in this area could be costly.
- Don’t forget to pay the option fee. Until the owner has received it, the agreement isn’t legally binding and the seller could have grounds to back out of the whole arrangement.
- Don’t underestimate the power of working directly with property owners. When you’re negotiating directly you can find out what the seller’s needs are and work out ways you can deliver a win-win outcome.
- Don’t give any personal guarantees regarding settlement.
- Research is critical – don’t cut any corners. You need to know exactly what you’re dealing with, who your target market is and how to get out quickly and painlessly should the need arise.
- Don’t be greedy. If you’re making a small amount of money on the deal in a short space of time, and there’s no risk for you, be happy with that.
- Don’t get distracted with multiple strategies. Focus on one type of option arrangement, whether it’s single land lots or development sites.
- Don’t aim too high too quickly. If you’re not careful, a cutthroat operator could bypass you on deals or void your options. Don’t take the risk by doing big deals early on.
- Don’t be a pushover when it comes to sellers who feel remorseful. If they change their mind once all the paperwork is signed, remain firm.
Nhan Nguyen is the founder of Advanced Property Strategies. He is also the co-author of the book Property Millionaire www.advancedpropertystrategies.com.
Copyright Australian Property Investor magazine - www.apimagazine.com.au. This is an edited version, reproduced with permission.