“Buy-Back” Options are used in many areas of business. Banks and Money Market Mutual Funds routinely increase their yields by selling government securities with the right to buy them back at a price that will generate a yield that will attract buyers.
When a real estate negotiation bogs down because of a difference in perceived value between the parties, the seller might agree to the buyer’s offer, but only if he could buy the property back at some point in the future at far enough above his sale price to give the purchasers a market yield when it is bought back. In so many words, they let the market set the price.
This way, the seller can lock down the price when a falling market seems likely to get his hands onto cash, but continue to try to get a better deal later on by exercising his buy-back Option when he finds a buyer who will pay more.
This is also a great way to raise money from an investor. As an investor, I was approached by developer to buy a 120 acres of vacant development land. He had a chance to buy the adjacent section, and if he bought it all, he could get it for about 20% of the fair market value of smaller parcels. The problem was that he hadn’t enough cash to buy it all, and banks weren’t lending money on bare land. He needed an investor, but didn’t want to give away all the potential profit in the deal.
Here’s what he did: I agreed to buy the bargain priced quarter section of land, but had to give him an Option to buy half of it back for half of what I paid anytime the property was going to be sold. This had benefits for both of us. From his point of view, his overall price for the land would be considerably lessened by his buying it all; and he could control how it was developed to assure himself of top retail dollar. While he was awaiting a buyer, none of his money would be tied up in the land. When the smoke cleared, the profit he gave up to me was just about made up by the cost he saved on the price of his own 640 acres. He won’t need any more money because he’ll only exercise his Option when he has a buyer for the entire parcel.
From my point of view, I got to hang on to the financial coat tails of a very successful land developer who discovered this opportunity and cut me in. My only cost is tying up money for my whole parcel and not being able to realize profit on half of it. On the other hand, by giving up half of my future profit, by being able to buy the land as part of the entire parcel at 20% of fair market value, I’ll still realize about a 500% profit on the other half when it sells. This was made possible by a buy-back Option.
