Property option agreements
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.
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A property option agreement is a contract between a vendor and a buyer. Under this contract, the parties agree on a purchase price at a specified time in the future. The buyer also has to pay the vendor an option fee.
Property option contracts allow a seller to lock in a specific price in the future and give the buyer time to find the funds. These agreements are common between landowners and property developers wishing to develop a piece of land.
How do property option agreements 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, the vendor doesn't have to move right away, which gives them time to find their next property. And it gives the buyer time to get the funds together for the purchase (and to lock in a price).
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.
The option fee is usually a percentage of the sale price, typically between 3% and 10%. This fee may form part of the deposit, and depending on the details of the contract, the fee may be refundable if the purchase falls through.
What are the different types of option agreements?
Option agreements usually contain 2 options: put and call options. Most agreements combine 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 agreement: 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.
How do developers use option agreements?
The strategy for the buyer is to add value to the property through upgrading or renovating the property. It also gives the buyer the ability to negotiate a low purchase price for the option. Then they sell the property for a profit.
This strategy requires a vendor who will agree to an option agreement. This often means a vendor who has had trouble selling the property or doesn't have the cash to improve the property.
Property option agreements can work out well for both parties. A savvy buyer can lock in a good price and then spend money to improve the property before selling it at a bigger profit – all before they even need to come up with the full purchase funds. For a vendor who has been unable to improve or sell the property themselves, an option agreement is their best chance to offload the property.
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 developers the opportunity to purchase properties at a competitive price, add value and then see a profit.
- Flexible terms. Options can be useful when you want to agree on the terms of a transaction, but you want to hold off on paying until settlement.
- Contract complexity. Property option contracts are more complex than a typical real estate contract and therefore involve greater time to prepare and more legal expenses.
- Risk. The development can't go ahead if the council doesn't approve the development proposal. But this is always a risk in property development.
- Site promotion. You may be responsible for promoting the site for development through a planning process, which can be costly and time-intensive.
How do I minimise risk with an option agreement?
The most common ways of reducing investment risk are to conduct thorough research into the market as well as local council and property legislation that may affect the build. You also need to do your due diligence by forecasting financial and cash-flow viability with an accountant or financial planner and having the contract reviewed by a professional.
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 the 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 have an understanding of council regulations regarding zoning and subdivision.
- 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.
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 property investment loan. Compare the home loans below to see if there's one that suits your investment needs.
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We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
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