AMA - Writing An Option Contract
On today’s show we’re answering another listener question.
Emilio from El Paso Texas writes,
I continue to enjoy your podcast every morning. I want to ask you if you had any references that you could share regarding how to adequately price an option to buy a piece of land. Any help would be appreciated.
Emilio, this is a great question.
Let’s define first what we mean by an option. An option is quite simply a contract where you the buyer have the choice to buy a property, and the seller has the obligation to sell the property to you if you exercise your option. But if you don’t exercise the option within the option period defined in the contract, the contract is cancelled.
There are several ways you can structure an option in order to meet your specific needs as a buyer.
Depending on the nature of the project, you may require more or less time to exercise that option.
The terms that will be acceptable to both buyer and seller are a function of the amount of time you want the option to remain in effect.
In a lot of cases, if that conditional period is short, in the range of a few weeks, maybe even a couple of months, you might pledge a fully refundable deposit. In that case, you are getting a completely free look.
But if you’re looking for a longer time period and the seller actually wants to sell the property, then they will likely demand a higher payment in exchange for the uncertainty in the sale of the property.
I often see contracts written where there is a refundable conditional period of say, 90 days. That’s a free option. You might then negotiate a few extensions into the conditional period where there could be a hard payment paid to the seller in exchange for the extension.
Look at the contract from the seller’s perspective. They have to endure the uncertainty of the property not selling at all, and in the meantime, they’re barred from selling the property to anybody else who might come along with a firm offer. Most sellers are uncomfortable with that uncertainty. So if they are going to endure that uncertainty they will want to be compensated for it. As a minimum, you want to figure out what the holding cost would be for that period of time and consider offering an option consideration that would cover the holding cost. At least the seller’s holding cost goes to zero and the impact of continuing to own the property would go to zero.
It all comes down to understanding the seller’s needs and negotiating a win-win deal between you. There is no one set formula.
Host: Victor Menasce