Understanding the basics of real estate options

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When it comes to real estate investing, there are many ways to get involved in the market and make a profit.

 

A homeowner might put their home on the market and choose to sell it to anyone who makes an offer they like. Real estate investors might rent out a property they own or sell it for a profit once it appreciates in value.

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Although investing in a single property may be very profitable and safe, it’s not the only way to benefit from the real estate market. Another way to sell and invest in real estate is through real estate options. With an options contract, a particular buyer is granted the exclusive right to purchase the property at a particular price, but they are not obligated to buy it. This is a flexible and typically less expensive way to enter the real estate market that may also help reduce risks involved in a single property investment.

 

Related: Call vs. put options: Main differences

What Are Real Estate Options?

Real estate options are contracts between a buyer and seller. They grant the buyer the exclusive right to purchase a particular property within the terms set in the contract. But the buyer doesn’t have to purchase the property.

 

An options contract for a purchase is also known as a call option, whereas an option to sell would be called a put option. Once the agreement is entered into, the property owner can’t sell to anyone else within the time period set in the option.

How Do Options in Real Estate Work?

Generally, real estate options set a particular purchase price and are valid for anywhere from six months to one year. The buyer doesn’t have to purchase the property, but if they want to, the seller is obligated to sell to them even if the market price has gone up.

 

The buyer pays what is known as a “premium” in options terminology to enter into the contract. If they decide not to buy the property, the property owner keeps that premium.

 

Real estate options are most often used in commercial real estate, but they can be used by retail investors as well. They aren’t sold on exchanges, and each contract is specific for the property it represents. Usually, a contract is only for a single property, not multiple properties.

 

Real estate options are similar to stock options in that they set a specific price, premium and period of time for a contract related to an underlying asset. Options can be exercised early or at the expiration date. They can also be sold to another investor.

 

Most of the benefits involved in real estate options are for the buyer. For a seller, there isn’t much benefit, but there is a potential for them to make a profit on the premium if the buyer doesn’t exercise the option.

Lease Options

In addition to real estate options for purchases, there are also lease options. These are rent-to-own agreements between a buyer and seller. They let someone lease a property with the option to buy it after a certain amount of time but not the obligation.

 

Generally, with a lease option, some or all of the rental payment goes toward the purchase. Some lease options lock in a particular price, but others just give the buyer the exclusive right to buy at whatever the market price is.

 

Although lease options can be great for buyers, they are also more expensive than simply renting a property since they involve a premium. For this reason, it’s important for a buyer to carefully consider the contract and their future plans before entering into a lease option agreement.

2 Advantages of Real Estate Options for Buyers

Options are a common investing strategy for commercial real estate investors. There are several reasons a buyer might enter into a real estate option contract with a seller:

1. It Can Allow Time for the Buyer to Amass Funds

One might choose a real estate option if they want to secure a piece of land or property at a certain price but they need some time to get funds in order for the purchase.

2. A Real Estate Option Locks in a Price

If a buyer thinks the price of a property might go up, they can purchase an option to lock in the current market price. However, some real estate options are not completely set in their sale prices. There may be clauses in the contract to determine what the final sale price will actually be.

2 Advantages of Real Estate Options for Investors

Real estate investors can also use options to their advantage:

1. It’s a Lower-Risk Way to Develop Property

For example, let’s say an investor finds a property they’re interested in developing into housing. The investor needs to create a plan for the property and get other investors involved before they can buy it, so they purchase a real estate option to give them the exclusive right to buy the land.

 

The investor can make a profit by bringing in investors at a higher rate than the option. They can then buy the land and sell it to the developers they brought in to make a profit.

 

If they aren’t able to get developers and investors involved before the contract expires then they simply don’t buy the land.

2. An Investor Can Buy and Sell Real Estate Options

Investors can also make a profit just by buying and selling real estate options contracts rather than the properties themselves. This is a much less capital-intensive way to get involved in real estate investing. For instance, an investor might find a property they expect will increase in value in the coming months. They purchase a real estate option to buy the land at the current market rate within the next year, pay a premium and wait.

 

At any point during the period of the agreement, the investor can either act on the contract and buy the property or they can sell the contract to someone else. Let’s say the value of the property increases three months into the contract. The investor can find another investor who wants to purchase the contract for them for a higher price than the premium the original investor paid.

 

Whether any investor buys the property or not, the seller of the property keeps the premium.

The Takeaway

Real estate options are a way for investors to get involved in real estate investing without directly buying properties. As with any other kind of options, the investor buys the right to buy or sell at a certain price but is not obligated to do so.

 

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