HOW
CAN WE HELP YOU? :: Vacant Land
Consider the Options
Savvy investors can conserve capital and create leverage through
options.
By Thomas J. Lucier
When fully understood, properly prepared, and used correctly, real
estate options are an excellent way for knowledgeable investors
to conserve capital, create leverage, and reduce risks. Investors
and clients who may be short on capital may find options a good
strategy for controlling properties with resale profit potential.
Investors can shield their options profits from federal income tax
by purchasing real estate options through self-directed individual
retirement accounts. Investors are advised to use the services of
qualified professionals when buying options through IRAs.
Profitable Opportunities
The key to being a successful options investor is knowing which
properties to option to create equity without investing exorbitant
amounts of time and money. Only about two out of every 10 properties
are potential options properties. The most profitable properties
for real estate options usually have one of these conditions:
- rezoning potential;
- condemned for code violations;
- underutilized;
- cosmetically rundown;
- obsolescent flaws, such as an outdated facade; and
- correctable problems, such as flawed titles or mold that make
them non-marketable.
Vacant land located in the path of future growth can present opportunities
to profit from options. Savvy investors can use public information
on projected government infrastructure expansion projects, such
as road construction, to plot the path of growth and buy options
on vacant land located in the vicinity.
Options Strategies
The most profitable options deals usually are created by imaginative
investors. Using local market knowledge, they identify unfulfilled
market needs, find properties that best fill those needs, and put
those properties under option.
One strategy is to sell the option to a buyer who has a use for
the property. Selling an options agreement to a third party requires
the assignment of the real estate option agreement and provides
an assignment fee. This strategy eliminates property transaction
costs and avoids any legal recourse that may result from not purchasing
the property.
Buying options on properties located in emerging commercial areas
that can be rezoned for more profitable uses is another strategy.
An investor can buy an option on a vacant single-family house and
then apply to the local zoning authority to have it rezoned for
use as a professional office. Once the rezoning request is approved,
an investor can either resell their option, or exercise it and buy
the property. This strategy can be very profitable as converting
property is much less expensive than acquiring land and putting
up a new building.
An often-overlooked strategy is buying options on properties that
have been destroyed by natural or manmade disasters. Astute investors
can search out property owners who have been reimbursed by their
insurers for their losses but have no desire to rebuild. The investor
buys a one- to two-year option to purchase the property at a bargain
price and clears away the rubble. The investor waits until the recovery
is well underway and then resells or exercises the option. This
strategy has a lot of profit potential because of the lack of competition
from other investors.
Creating Agreements
Investors should protect their positions during the options periods
by using well-written real estate option agreements that clearly
define the terms, conditions, and provisions of the agreement, along
with the rights and responsibilities of both parties. Have a board-certified
real estate attorney draw up your options agreements. Option agreements
must include the following provisions:
Option Fee. Include the full amount paid as the
option fee and state that it is to be credited toward the purchase
price when the option is exercised. The amount of the option fee
is negotiable and depends upon the length of the option period and
the value of the property. As a general rule, never pay more than
5 percent of a property's value as an option fee.
Option Period. State the exact length of the real
estate option period by calendar dates. Try to negotiate six-month
to 12-month option periods.
Purchase Price. Specify the fixed purchase price
of the property under option, including how the purchase is to be
financed. Financial tests are not usually necessary.
Exercise of Option. Outline exactly how the optionee
is to exercise the option to purchase, including the method for
notifying the optioner. Send the optioner an exercise of option
notification letter by certified mail, with a return receipt requested.
Option Period Extension. State the optionee's
right to extend the option period, including the length and cost
of each extension period. Aim to negotiate three-month to six-month
extensions at no more than $500 a month.
Option Agreement Assignment. Include a clause
that gives the optionee the right to assign the option agreement
to a third party. Failure to include an assignment clause could
preclude an investor from reselling the option agreement.
Eminent Domain. Specify that the optionee will
receive full refund of the option fee plus interest if the property
is condemned by eminent domain during the option period.
Right of Entry. Include the optionee's right upon
notifying the optioner, to enter, clean , repair, market, and show
the property.
Risk of Loss. Specify that the optionee is entitled
to a full refund of the option fee plus accrued interest if the
property is damaged or destroyed by fire, storms, and earthquakes
during the option period.
Further Encumbrances. Include that the optioner
is prohibited against placing any additional encumbrances, such
as mortgages or deed of trust loans, against the property during
the option period.
Title Transfer Documents. State that a warranty
or grant deed and purchase agreement with the notarized signature
of the optioner is held in escrow by a reputable attorney or title
or escrow company, during the option period.
Recording Option. If permitted by a state's recording
statute, specify that the optioner must execute and acknowledge
a memorandum of real estate option agreement suitable for recording
in the county's official public records, where the title to the
property under option is recorded. Recording a memorandum of option
gives the public constructive notice that the property has an option
to purchase on it.
Potential Risks
Although real estate options are comparatively low risk, they are
not totally risk-free. Potential risks that investors cannot control
include foreclosure on the property, the property being placed under
the control of a federal bankruptcy court trustee, and having a
property taken as part of a government asset forfeiture lawsuit.
As part of the due diligence, investigate property owners to see
if they are involved in any pending or ongoing litigation that could
adversely affect the property's title.
“Consider the Options”
© CCIM Institute.
Reprinted with permission from
Commercial Investment Real Estate, volume XXIII, no. 6, p.10-11.
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