Property option agreements give buyers the right to buy or sell a property at an agreed price in the future, which can help investors manage their tax liabilities.
While many investors are skeptical of ‘little-money-down’ deals, there are many reasons why you may want to purchase property with limited funds. Whether you’re a low-income earner or struggling to make ends meet, property options are useful provided that you do your homework.
Like any investment strategy, property options do not come without a degree of risk for both the landowner (or vendor) and the developer. From the perspective of the buyer, these risks may present in the form of tax and stamp duty implications.
All risks should be carefully considered before you decide to enter into a property option agreement.
What are property options?
A property option is an agreement between a property owner and a developer, which allows companies to share with you the profits of the final development, while paying you a higher price for your original asset.
The person granting an option is known as the optionor (or grantor) and the person receiving the benefit from using an option is referred to as the optionee, or the beneficiary.
An option agreement is where a landowner grants a property developer the exclusive right to to purchase their land at an agreed price. A non-refundable fee is typically charged for this option agreement, and during the term of the option agreement, no one else can buy or sell the property.
How do they work?
An option is essentially an agreement made between a vendor and a developer to exchange land for an agreed price at an agreed time. This allows the vendor to achieve a higher than market value for their asset. As option terms are normally around 24 months, you don’t have to move right away which gives you time to find your next property.
The agreement between the vendor and developer is secured with the payment of an option fee to the vendor. After this, a developer is granted a certain amount of time to improve the value of the land by obtaining a Development Approval (DA) from the local council.
Once the DA is in place, the value of the property is likely to appreciate which will be reflected in the premium that the developer will offer you. The property is then sold in accordance with the original agreement, and construction can begin.
What are the different types of options?
Option agreements typically involve a “put option” which is an option to require a purchasing party to purchase the property within specified terms, a “call option” which is an option to require a landowner to sell the property within specified terms, or a combination of both.
- Call option agreement: A call option gives one party the right to buy something at a future point in time at a predetermined price.
- Put option: A put option gives the seller the right to compel the buyer to purchase the property at a specific price in the future. However, it is uncommon for put options to exist independently of a call option.
- Put and call option agreement: Put options and call options are generally combined in one transaction. These give the beneficiary the right to require a grantor to buy or receive property at an agreed price. That is, the buyer can “call” for a contract to be entered into, or the seller can “put” the contract to the buyer.
What’s the strategy involved?
The strategy for the buyer is through value-adding activities by finding ways to boost the property value and onsell the asset for a profit. However, this strategy requires a vendor who will agree to an option agreement, such as a distressed seller.
As an investor, you need to have the opportunity to add value to the property, such as through a cosmetic renovation or upgrade, as well as the ability to negotiate a low purchase price for the option.
You also need to be careful about the sellers you target, as few vendors will be inclined to agree to an option unless they have had some difficulty selling their properties.
What are the pros and cons of using property options?
As a landowner, there are benefits and drawbacks to entering into property option agreements.
- Profitability: A property option contract may give you the opportunity to yield a profit if you substantially increase the value of the property and onsell to a distressed seller.
- Flexible terms: Options can be useful when you want to agree on the terms of a transaction, but you want to hold off until settlement.
- Contract complexity: Property option contracts are more complex than a typical real estate contract and therefore involve greater time to prepare. Additional time is also required to negotiate the terms of the agreement with the vendor.
- Costly: Not only are they time-intensive, but property option contracts can be costly to create due to significant legal expenses required.
- Risk: There is a risk that you may encounter red tape or a non-proactive council which could delay your development or inhibit your profit.
- Site promotion: You may be responsible for promoting the site for development through a planning process which can be costly and time-intensive.
How can I finance a property option agreement?
Depending on the size and scope of the option development project, you can potentially secure sites with a residential home loan and use other forms of funding to pay for the associated subdivision fees.
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Are there any strategies that can minimise investment risk?
There are many exit strategies within the option land process which can lessen your investment risk. The most common ways of reducing investment risk are to conduct thorough research into the market, local council and property legislations that may affect the build, and practicing due diligence by forecasting financial and cash flow viability with an accountant or financial planner, and also seeking legal advice to have the contract reviewed by a professional.Back to top
What considerations are there for an option strategy?
Option agreements are a common way for developers to secure development sites as they provide them with flexibility and also assist with managing cash flow and liability.
As an investor, you should be concerned with maximising the flexibility of the arrangements, without resulting in adverse tax and stamp duty ramifications.
- Managing liability: With regard to statutory warranties for residential development, consider the terms of legislation such as the Home Building Act 1989 and other relevant legislation.
- Tax implications: Carefully consider the capital gains tax (CGT) and stamp duty implications as stipulated by state government and legislation such as the Duties Act 1997.
- Market research: You will also need to conduct thorough market research of property values and market trends, as well as an understanding of council regulations regarding zoning and sub division.
- Professional network: Network with property experts, local real estate agents, mortgage brokers, conveyancers, legal professionals and financial planners to ensure that you find the right land to suit your investment strategy.
- Degree of risk: You need to be comfortable with exercising a degree of risk when entering into a property option agreement as there is the chance that you may not benefit financially.
What should I ask myself before entering into an option agreement?
As an investor, you should develop a checklist and consult the vendor regarding the following:
- Does a put option agreement suit my needs and strategy? By speaking with professionals such as a financial planner, accountant, local agents and a solicitor, you can determine whether or not this type of arrangement will complement your strategy.
- Am I comfortable with the degree of risk that this strategy involves? You need to have a complete understanding of the risks involved when entering into an option agreement, and by speaking with a team of professionals, you need to decide whether or not you’re comfortable with enduring the risk.
- Am I receiving a fair price and how is it calculated? As the price may be negotiated a year or more in advance of the sale, you need to ensure that the price will reflect the future market value at the time it sells.
- What is the option fee? You should find out whether this fee is included in the price or not.
- Will an extension period be granted? If so, what criteria has to be satisfied? For example, in the event that you encounter delays when accessing finance.
- How will the price be calculated? Whether it is a base figure or another means, you need to be clear about what the price is and the method in which it is calculated. For example, the consideration price may be nominal, say $50, which means that the only stamp duty payable until the contract comes into effect is negligible.
- How is GST treated? Will GST be paid on the option fee and any other associated costs as stipulated by the contract?
- Who will cover expenses? Will you be responsible for covering expenses such as council rates or land tax?
How do I go about setting up an option agreement?
Occasionally, vendors will take active responsibility in promoting their property for development through the planning process, and thus you may be able to contact them directly.
However, it is more common for vendors to invite developers to submit offers for an option to purchase their property for a future development project.Back to top