Options, Pt 3

Options, Pt 3

Jason Cochard for Land Academy

This is the third installment in a series on real estate options. In a perfect world, an option will allow you to preserve cash until the second transaction is lined up. You get the exclusive right to purchase, and you begin to market the property as if you own it, without actually owning it. You only take financial risk after finding a buyer. You get to take the uncertainty out of the business.

But then we looked at the issues that re-introduce uncertainty when using options. And I mentioned that an option deal has never gone correctly for me — the seller has always been too much of a headache, and the deal begins to float away, despite a signed contract.

In one of my examples of problems with options, I mentioned that many people google it and find articles describing a “lease option” and assume you’re proposing doing a lease-option where you pay them installments and then own it after a few years. None of the sellers we talk to area likely to want to do this. Technically, it’s not your fault that they don’t know what you’re talking about and google gives them misleading information, but it’s still your problem. You’ll be the one to talk them off the ledge when they tell you you’re doing a bait-and-switch on them — after all, your letter said you could close fast.

Going off the premise that #1 the option agreement is a confusing concept, and #2 the seller just wants their money, we need to work with familiar concepts, and present the comfort that the money is going to flow soon, in a predictable way.

My personal option remedy

The best way to avoid the uncertainties inherent with option deals is to use a purchase agreement rather than an option agreement. Using a purchase agreement defeats the seller confusion because it’s more familiar than an option. And when you want some time to find a buyer before closing, there are 2 ways to achieve it without setting off alarm bells with the seller.

First, simply extend the closing period. Instead of a normal 30 day escrow, maybe you go 45 or 60 days, and you write it into your contract. You’ll begin marketing the property immediately upon contract signature, so you’ve already got some time before money needs to change hands.

Secondly, you can add another familiar thing to the contract that normal people are likely to understand: a due-diligence period. Adding a couple weeks or even a month for due diligence is something that routinely happens in real estate deals. If you don’t want to continue with the transaction during the due diligence period, you can kill the deal, but you’re tying up the property for the due diligence period in order to give you the assurance the property won’t be sold after having done a bunch of research on it. Sellers understand that, and can work with that. They probably negotiated something similar when they bought their house.

Comparing a 90 day option with the scenario described above:

Option Agreement

  • 90 day option period
  • Option is exercised and sent to escrow
  • 30 days for escrow
  • 120 days total

Purchase Agreement with extended closing and due diligence

  • 30 day due diligence period
  • 60 days for escrow
  • 90 days total

The difference is within the margin for the kinds of deals we should be entering into. That is to say, if you can’t sell a property in 90 days, it’s over priced or your marketing is ineffective. We should be doing deals that fly off the shelves due to price being well below retail. 90 days should be ample time for that. Can it still be hard, even when your price is low? Yes, and I’ve also had that happen — the remedy is building a solid buyers list, so that you dramatically increase your chances of finding a buyer within your due diligence period.