Areal estate option contract gives you the right to buy a property without the obligation of having to buy it. In a normal purchase contract, when the buyer and seller have a meeting of the minds and sign the contract, the buyer must perform and go through with the agreed-upon purchase. If the buyer does not perform based on the terms of the contract, the seller can sue the buyer for specific performance.

An option contract allows the buyer and seller to have a meeting of the minds, sign the option contract, and offer the buyer a time certain to exercise the option. If the buyer does not exercise the option, the option expires, and the buyer owes no further obligation to the seller.

Put another way, an option contract gives a potential buyer the right to purchase a property before the specified future date in the contract for the amount and under the terms and conditions written in the contract.

Optionor/Optionee

In an option contract the parties to the contract are the optionor and the optionee. The optionor gives real estate paperwork-the option contract-to the optionee. In return the optionee gives money to the op-tionor for granting the option. This is called the option fee. The seller is the optionor. The buyer is the optionee.

Option Fee

The option fee is the consideration given by the optionee to the optionor. This is what satisfies the consideration requirement and makes an option contract valid. As we have said, in return for the option fee, the optionor gives the option to the optionee to purchase the property.

The option fee is usually a percentage of the agreed-upon purchase price for the property. This percentage can range from as low as 0.5 percent on a higher-priced property to as much as 10 percent on a lower-priced property. For a $100 million purchase price the option fee may be $500,000. On a $300,000 purchase price the option fee may be $30,000.

Option Fee Percentages

$100,000,000 Purchase Price $300,000

X 0.5% Option Percent X 10%

$ 500,000 Option Fee $ 30,000

The option fee can be applied to the purchase price in the event that the optionee exercises the option to purchase. Sometimes the option fee does not apply to the purchase price. This may happen when a second or third option time period is negotiated. We always negotiate the option fee applying to the purchase price. That way, if we exercise the option, we already have past money credited to the deal.

Option Fee Applied to Purchase Price We made an offer on a five-bedroom, four-bathroom, 5,000-square-foot, single-family home in a great neighborhood. Our offer was in the form of an option contract. We wanted a six-month option period because we were concerned about which way the real estate market was headed.

Were we still in the prosperity phase of the real estate cycle? Or were we headed into a recession? If the real estate market was still going in an upward direction, we would buy the property. If the real estate market was headed in a downward direction, we were not going to buy the property.

We negotiated the option fee to be applied toward the purchase price if we exercised the option. If we did not exercise the option, the seller would keep the option fee. In this case the option fee was $2,500. Although this was a very small percentage of the $300,000 purchase price, the seller still accepted our contract.

Option Fee

Purchase Price Option Fee Remaining Balance

$300,000

$ 2,500 $297,500

Option Fee Not Applied to Purchase More frequently than you might expect, the negotiated option fee does not apply to the purchase price. Home builders often acquire finished lots for construction through option contracts with a real estate developer.

In many cases the home builder will want to extend the option past the original time period. Lets say the first option period was for six months. An extension could be needed by the home builder because the builder was unprepared to start building.

To extend the option period for another six months, the developer may require another option fee from the builder. Sometimes the second option period may be extended to a third or even a fourth option. Although the developer may have been willing to apply the first option fee toward the purchase price of the lots, the developer may not be willing to apply any of the other fees to the purchase price once an extension or extensions are agreed to.

When you use a real estate option contract, you can tie up a property without revealing your interest in the property. It gives you the right to buy the property without revealing your identity. Once you close on a property, your name is revealed in the public record as the buyer of the property. You can wait to exercise your option until you have put together all the pieces to your overall real estate plan.

Walt Disney assembled the property for Walt Disney World in Florida using option contracts. He did not want to tip his hand to the many different property owners from whom he needed to purchase property. If remaining property owners knew he was buying property, they could hold out for a higher price. Disney would have had to pay big bucks once word got out that he wanted to put all the properties together for Walt Disney World.

Why Use an Option?