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I posted a new article about options at the blog
you can see it here
https://www.cashflowdepot.com/blog.aspxHere are some additional questions and answers about options (from jack’s Real Estate Investors Most Frequently Asked Questions Manual)
PURE OPTIONS…LOW RISK LEVERAGE
Question:
What type of transaction have you found to be the most profitable?Answer:
With investments you never know which will be the most profitable until the final inning. Since we don’t advocate SELLING investment property, profit is difficult to assess. Where we have made the highest yield based upon invested capitals, Options and Lease/Options clearly take the cake. Typically, I’ve bought 6 month Options at 80% of current fair market value on a $100,000 house for $100. By selling the Option itself or the property at a price which would be 90% of fair market value, I’ve made $9900 or 990% on my investment within the 6 month period. That’s quite typical.The real profits are made when an Option is used to control larger properties such as businesses, apartments, condos, land, etc. Direct ownership of these larger properties wouldn’t be feasible for most people because of the costs of operation, management, interest, taxes, insurance, etc. On the other hand, buying a pure Option eliminates all expense other than the initial costs, giving the Optionee time to let the market rise or to find a buyer.
Question:
I keep hearing about buying and selling options, but I don’t really understand how they work. Please expand on this subject for me.Answer:
An option is a contracted obligation to leave an offer (to either buy or sell) open for a stated period of time. This obligation is purchased from the Optionor by the Optionee for a consideration which might be anything they can both agree on. Once purchased, the option gives the holder control over rights of sale in a property under specified terms and conditions as to price and payment. Options should be recorded to protect the purchaser, and where large sums or long terms are involved, a Mortgage or Deed of Trust should also be recorded to secure it against any intervening liens or transfers of the optioned property.In most cases an Option can be structured to prevent any further encumbrances including leases and mortgages. Under current tax law, if held 12 months or more an option can be sold for long term capital gains. When combined with a lease, an option can produce cash-flow and all documents necessary to close the sale can be held in escrow, fully executed, to provide for quick action. In short, an Option is just like a contract to purchase which has been signed by the Seller but not by the purchaser, with the time of acceptance held open for the entire term of the Option. It has all the provisions of any purchase contract to protect everyone.
Question:
What is the ideal vehicle on which to place a five year Option?Answer:
When we have an Option for five years, the only real benefit we will realize is the appreciation of that property. The cash flow, depreciation, and what little mortgage pay down there is will most probably go to the original owner. Therefore, we should choose a property on which we can acquire an option with as little consideration as possible relative to the amount it will appreciate during the period.Quite often Options on houses can be acquired for as nominal consideration as one or two years’ back taxes. On land investment, when one finds an owner of land who has mortgage payments due and is unable to make them, an Option might be picked up on the property in consideration of making one mortgage payment. Always keep in mind, when negotiating for an Option, that Options are purchased, not given away. Sometimes I hear the comment, “He would not give me an Option” and my response is “How much did you offer?” Rarely is the consideration offered, sufficiently beneficial to the seller, hence no deal!
Question:
How might a Broker structure an option to provide a buyer with a down payment, enabling him to qualify for a loan, then later arrange to purchase the house from him advantageously once he no longer needs it?Answer:
This formula works well anytime you have a buyer for a property you own or have listed. The buyer must have the ability to qualify for the necessary loan EXCEPT FOR THE CASH NEEDED for the down payment and closing costs. Suppose he needed $3,000 down to finance the purchase of your listing on a house with a $5,000 commission payable to you. You would contract to purchase an Option on the house from the buyer for $3000 prior to its being bought. This Option would be delivered and signed by the Buyer simultaneously with the Deed at the closing, and would be recorded just behind the Mortgage and Deed.At closing, you would be paid the real Estate fee of $5,000, and you would pay the Buyer the $3,000 for the Option. He, in turn, would give $3,000 to the Seller as down payment. The Seller would sign a Deed; your Buyer would sign the mortgage and immediately afterward he would sign the Option in your favor, (or your assigns). Option terms could be structured as a pure Option, or as a right of first refusal Option as desired.
Question:
When renting with an Option to buy, should the Optionee (renter) try to negotiate the Option price and terms at that time, or should one settle on an “easy” fixed price which the Optionor will accept, hoping to re-negotiate a lower price at time of exercise of the Option?Answer:
Generally, the price and terms of the Option are contained in a purchase contract which becomes effective upon exercise of the Option to purchase. These should be negotiated at the time the Option to purchase is being considered. When a fixed price on a mortgaged property is negotiated, then the amortization of the loan is in favor of the current owner. But when a fixed sum of money over the loan balance is negotiated, then the Optionee gets the benefit of all loan amortization.Nothing prevents the Optionee from continuing to negotiate with the Optionor AFTER THE ORIGINAL CONTRACT HAS BEEN SIGNED, however, some courts have held that this constitutes a counter-offer which effectively rescinds the Option. Therefore, re-negotiation should be under taken only when the Optionee is willing to lose the transaction in the event that negotiations break down and the Option is in-fact canceled as a result.
Question:
When negotiating an Option to purchase, either as part of a lease or as a pure Option, should one set up terms of payment as well as the price? What other items is an option are negotiable?Answer:
Everything about an Option is negotiable! Perhaps this question should read: ” How does one negotiate?” In buying an Option, as in all negotiation, one must ascertain the degree of motivation on the part of the seller and the underlying reason for it. If there is an immediate need for cash, then the buyer can dangle cash while bargaining for all terms and lease provisions. If the Optionor wants out of management, then Option terms may be very liberal as to payment, interest rates, Option period, price, etc.Since an Option is a form of contract, one should include price, terms, occupancy, title examination, closing date, responsibility of parties, any persona property, financing, zoning, improvements, etc. Each of these can be bargained for as a condition of doing business. A complete discussion of Options together with specific terminology is contained in the Option Primer which is included in my Basic and Advanced Options seminars.
Question:
When depositing Option consideration with the Optionor, are the funds a part of the purchase price? Can one depreciate the property being acquired under Option?Answer:
In general, Option consideration can be considered part of the purchase price or not depending upon the agreement between the parties. If it is a part of the purchase price on a capital asset, it becomes part of the basis when the property is purchased. It is ordinary expense if the Option is allowed to lapse, and it is taxed as capital gains if the Option is sold after one year. If the property under Option is “Dealer Property:, the same rule applies, except that gain from sale of the Option is taxed as ordinary income.
Now when the Option consideration IS NOT part of the purchase price, it is an ordinary expense to the Optionee, and ordinary income to the Optionor regardless of the type of property being purchased.
Since an Option is merely a RIGHT to purchase, it cannot be depreciated until after the purchase has been completed.Question:
How is money that has been received as Option consideration treated for tax purposes?Answer:
Option consideration, whether money or property, or anything else, is ignored until such time as the option is either exercised or allowed to expire. At that point the Optionor’s tax treatment depends on the nature of the asset being optioned. When the option is EXERCISED, the consideration is treated as a capital gain if the asset under option was a capital asset. If it was dealer property, the consideration is treated as ordinary income. These rules apply ONLY if the consideration is part of the purchase price. If it is IN ADDITION TO the purchase price, then it is treated as ordinary income in all cases. If the option is allowed to LAPSE, then the consideration is ordinary income to the Optionor in the year of the lapse.Question:
We hear about all the profits to be made from single family homes, but it always seems to take a lot of money. How does one start to invest in this program when one has only a modest amount to work with?Answer:
Everyone starts at one time or the other with little money! One has to look at money in its true light. It is really only a symbol of value, and if that value can be replaced by something else, money is not needed. That’s where creative finance comes into play.Let’s say an owner needs to sell his house to transfer into another area. No one can afford to purchase his house and he is faced with the prospect of family separation, the costs of maintaining dual residences, and commuting between work and home on weekends. Now, suppose you offer to buy his house with a small down payment (or to rent it for an amount equal to the payments with an Option to buy it as soon as you can afford it). You agree to pay him for his equity as soon as financing becomes available. Isn’t it possible that he might accept the offer? By solving HIS problem he is motivated to accept terms normally not obtainable.
Question:
How do you work with an owner who has a non-assumable loan, like a Farm Home Loan?Answer:
The acceleration clause on these mortgages is usually triggered upon the transfer of the fee title to the property. Some loans, generally the subsidized ones, even have a prohibition against leasing. In the event that the owners’ motivation to sell is not that they WANT to move, but that they cannot meet some financial commitment, (like taxes, or mortgage payments), one might be able to acquire an Option in consideration for supplying the immediate cash need.For example, in one case, two year’s back taxes were overdue. They totaled $500.00, and the house would have been sold for taxes if the tax bill had not been paid. By paying the taxes, a two year option was acquired with only a small amount invested. Since no transfer of an assignable RIGHT to take title), no alienation had actually occurred. Thus, no acceleration of payments was triggered. Remember, control of the Right-to-Title can be just as lucrative as actual possession of title. The Option is the Key!
How did Jack come across properties/individuals that were willing to take $100 now for an option to purchase their property for a maximum of 80% market value? Was it because he was a real estate broker and individuals came to him. Then he listened and negotiated with them to get an option for 80% or less of current market value? Because, I do not have my realtors license, and I do not plan to get it. Also, I just recently bought the intro and advance option courses but have only made it through 2 CDS and very little reading. The answer might be in there somewhere, but I just haven’t made it that far yet.
I am assuming it would depend on what the sellers interest was, if they wanted a 6 month or 5 year option (when they were looking to sell). Correct?
Also, I’ve been talking to an older couple who wants to sell her property next year. I am looking at doing a regular option on the property (80% of current value), never done a regular option before. Would it be beneficial to get an option for 1.5 years and have it come active in 1 year and void in 1.5 years from now, but with that type of strategy, it would mean i would be like a realtor for the property. However, i do not have my realtors license (no access to MLS) but i still could market it. Any suggestions what to do for the property or do you need more information?
80% below market may NOT be the right number in this economy. If the house is in perfect condition, that number may work.
It just depends on where you live and what the housing market is like where you are. 80% would work in Dallas Texas but it sure would NOT work in Detroit Michigan.
If the house needs any repairs, you’ll need a bigger discount. If the house is in a less than desireable neighborhood or city or state, you’d need a much bigger discount.
sounds like a good topic for a conference call.
the kind of option depends on the type of property and your exit strategy
if it is a run down, old, ugly house that needs a lot of work, you need a short term option, for 30 days to give you time to find a wholesale buyer. The price on your contract needs to be about 30% below market MINUS repair costs. See my FLIP DEALS: Real Estate Profits on Steroids book in the free bonus section for details about how to do these kinds of deals and how to estimate repair costs
if it is a beautiful house that needs little work, then you could get an option to sell it with a highest bidder sale. This could be to sell to a cash buyer or sell for the highest down payment with seller financing
or
you could get an option that says, you will buy it with seller financing as soon as you find a good tenant
or
you could get an option that says you will buy it with seller financing as soon as you find an end users so you can sell it with seller financing that wraps the underlying loan
or
it could be a long term option where you just put it in the pipeline with several other properties that you can hopefully buy with seller financing or subject to the mortgage. then start marketing for buyers.
or
you can get a long term option with monthly payments made that reduce the purchase price (like seller financing) then sell your option on terms to someone else
or
the list is endless… there are so many ways you can use an option.
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