History can be a great teacher of techniques that can be a game changer in today’s real estate market. Real Estate evolved in the early 2000’s to a 100% financing contract that was negotiated solely on price. The creative real estate offers and strategies innovation in turn died. We started discussing the different category of strategies in the past article titled How to Execute a Sale-Leaseback Strategy. Today we chat about a speculation oriented investment strategy that first arose in the 1970’s.
Lease option sales were popular financing instruments in the late 1970s and early 1980s. They were primarily used as a way to creatively buy real estate in an environment where 100% financing did not exist and hard moneylenders were tougher to locate. Here is a dirty little secret that has not been publicized as much. Banks consider lease-options a violation of the due on sale clause so if a lender discovers that a property owner has entered into a lease option agreement, the lender could call the mortgage or deed of trust loan due and foreclose if the loan was not paid off in full (Review Title 12 of the Code of Federal Regulations which refers specifically to lease-option contracts).
Options are misunderstood but when they are fully understood, properly prepared, and used correctly, real estate options are an excellent way to conserve capital, create leverage, reduce risks, and gain control of properties with immediate resale profit potential.
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What is a Real Estate Option?
In legal language, a real estate option is an agreement that grants the party owning the option, the optionee, the exclusive, unrestricted, and irrevocable right to purchase property from the party selling the option, the optionor, during the specified period of time that the option is in effect. Real Estate options have six key elements:
- Optionee: Optionee is the party buying a real estate option.
- Optionor: Optionor is the party selling a real estate option.
- Real estate option: When an optionee buys a real estate option, he or she buys an exclusive, unrestricted, and irrevocable right and option to purchase a property at a fixed purchase price within a specified option period.
- Option consideration: the amount of money paid by an optionee to buy a real estate option from an optionor.
- Option period: the specific period of time stated in the real estate option agreement in which the option is in effect.
- Exercise of option: The exercising of a real estate option occurs when the optionee notifies the optionor, in writing, that he or she is going to exercise the real estate option and purchase the property under option.
What are the Benefits of a Real Estate Option Strategy?
If you are a speculative real estate investor then options can be more beneficial than flipping hard real estate. I know that most investor talk about flipping real estate and making tons of money in under 6 months. There is a grain of truth to those strategies but at times some authors forget to mention the roadblocks to flipping real estate:
- Title seasoning.
- Property appraisals.
- Scrutiny from lenders and title and escrow agents for possible fraud.
When used properly, real estate options strategy is an excellent low-risk, high-profit potential property control technique.
Related: The Book on Flipping Houses
What are the Best Types of Properties for an Option Strategy?
Buy options on assets that are in demand or are going to be in demand through creative repurposing or added demand from potential space users. Below are a few key types of assets that can be targeted for options strategy:
- Properties that can be upzoned for more the highest and best use.
- Mismanaged rental properties that can be turned around.
- Dirty, filthy, run-down properties that can be cleaned up.
- Properties with functional obsolesce that can be put to other uses.
How to Find Option Assets?
You need to develop a multipronged attack to find sellers of assets that would consider option strategy. The best techniques that I would recommend are as follows:
- Classified Ads
- Direct Mail
- Internet Marketing
I prefer direct mail that is geared towards marketing to out-of-town owners. Why out-of-town owners? Most out-of-town or absentee property owners become that way because they either inherited a property or, for whatever reason, were forced to relocate and failed to sell their property before they left town. Hence they are usually highly motivated and are looking for a solution to their problems. Send them a letter or a postcard, which should be relatively short, sweet, and to the point.
How to Resell Your Option for a Profit!
Lets assume that you searched, negotiated and tied up an option. Make sure to record a option memorandum at the county records vault so that your option position is noted within the chain of title. The next question that comes up is how to make a profit with this option?
The first step in the process of reselling a real estate option is to calculate its resale value. Always try to sell real estate options for at least 5 to 10 percent of the property’s market value with the option buyers end position in mind.
For example, on a property with a fair market value of $100,000 that you have an option to buy for $60,000, in such a situation I would price my option at $10,000. This way, I would be fairly compensated for the time and effort that it took me to get the property under option while the option buyer got a $30,000 discount from the fair market value.
The second step in reselling a real estate option is to create an information packet that provides the following pieces of information:
- The year the property was built, along with the type of construction and architectural style.
- The property’s geographical location, to include any special features or benefits about the area.
- A brief description of the building’s interior including but not limited to square footage and geometrical shape of the building, spacing between interior support columns, ceiling and overhead door heights, type of heating and cooling system, and the size and shape of the lot.
Market the property, not option. What you are really selling is the real estate asset that underlies the real estate option agreement itself.
Real Estate Options can be an amazing tool to utilize in your arsenal of investment strategies. For more details on this option strategy, read How to Make Money with Real Estate Options by Thomas J. Lucier whose great book helped outline a lot of the option strategy stated above.
Use this powerful strategy creatively and share your ideas or experiences on using options in the comments below.