An option is a contract. An owner of land (called the optionor) agrees to sell his or her land to a particular buyer (called the optionee) for a predetermined price. The optionee/buyer is not obligated to buy, though. He or she holds all the cards. The optionor/seller must sell if the other party demands it. The optionee/buyer does not have to buy, no matter how much the owner wants that to happen. The buyer makes no promises at all.
Because of technicalities having to do with contract law theories, the optionee (potential purchaser) must pay a fee to the optionor/seller in order to make the option contract enforceable. The fee does not have to be in any particular amount or any proportion to the ultimate purchase price. It just has to be an amount the owner finds acceptable. The fee pays only for the option. It does not pay for the property, nor is it earnest money or a down payment.
No, what you are describing is earnest money. If you try to make the money you pay for the option refundable or capable of being applied against the purchase price, then you do not have an enforceable option contract. Do not try to figure out any way to get around this! If you are serious about using options to invest, then be serious about making sure you can enforce them when the seller finds out his or her property is much more valuable than he or she originally thought.
There are two primary risks that an option controls. One is the risk that the purchaser will not be able to find another buyer at a higher price. The option lets the purchaser tie up the property with little or no cash while he or she hunts for a buyer.
The second risk is the danger that a developer will not be able to buy enough properties for a deal. A friend of mine recently purchased sixty-two parcels of land in order to bulldoze the World War II–era houses and build a shopping center. If five or six people had refused to sell for any price, the entire project would have been impossible.
Rather than spend the money to buy fifty-seven parcels and then find out that five other owners had the power to kill his deal, my friend optioned all the properties, one by one. When he knew he had a viable project that could go forward, no matter what some holdouts might decide, my friend closed on all the optioned real estate. If it had been necessary to walk away and abandon the venture, he would have been out the $100,000 or so it cost to buy the options, but no more. That is a lot of money to you or me, but it was small potatoes compared to the potential multimillion dollar profit on the shopping center development.
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06292010
1. Real estate Investments
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