Put and call options in a booming residential property market

The Sydney property market, especially the residential property market, is booming.  How long this will last, I have no idea, but I know it won’t last indefinitely.

I’ve noticed some increasing trends as a result.  One, that’s the topic of this article, is proposed option agreements.

Options agreements are agreements between a property owner and a buyer to enter a contract for the sale of land on a future date if one of the parties (sometimes either) to the agreement wish it.

An increasing trend I’ve seen many of my clients experience, is developers approaching residential landowners, where the land may be attractive for development, proposing to buy the land, sometimes for prices that seems quite flattering to the landowner, but often with certain conditions.

Usually, the residential landowner is inexperienced in these types of approaches and negotiations.

Developers often prefer options to buy land because it suits them.  They can use it to defer paying stamp duty on a speculative property purchase, or to avoid the purchase altogether.  As there is a delay, sometimes months, in a developer to prepare, lodge and eventually obtain development consent, if a property purchase isn’t delayed the developer sees the money spent acquiring the property so early in the process as dead money, or expensive money.  The developer is paying interest on loans and other property ownership expenses during this delay.

An option agreement allows the developer buyer to hold off buying the property until months later and, if it can’t get development consent, to avoid having to buy the property at all.

So, what is an option agreement?  There are usually two types:

Call Options

The party holding the call option is the potential buyer of the land.  A call option over land is the right of a buyer requiring a seller to sell their land to the buyer for a price at an agreed future date.

Put Options

A put option over land is the right of a seller to require a buyer to buy the seller’s land, again at the agreed price.

Sometimes both put and call options are combined in the one agreement, called a put and call option agreement.  Therefore, for example, if the buyer does not to exercise their call option, the seller can exercise the put option to force the buyer to buy the land.

Typically in option agreements:

• the buyer pays the seller a fee, often called an option fee, for the right to exercise the option by some future date, and preventing the seller from selling the property in the meantime to anyone else
• while there are no hard and fast rules, options fees are often equivalent to 1% of the agreed sale price of the land if the option were to proceed to a contract for the sale of land – I’ve see many agreements where the fee is much higher - if the option is exercised, normally the option fee is treated as being a part prepayment of the price
• the option fee is immediately released to the seller, non refundable to the buyer even if the option is not exercised
• parties must exercise their option rights within a time limit.

The examples above are not the only ways an option agreement operates, but it does give a sound general idea of how they work.

Seller Beware!

A landowner may consider there are benefits, including:

• the delay in selling may be suitable, knowing there’s a buyer committed to buy by a certain date
• the option fee immediately belongs to the seller, regardless if the sale occurs
• less stress in the selling process as there’s already a (somewhat) committed buyer and the price is known

Downsides to consider include:

• the seller is locked in!
• until the buyer exercises their option, if there’s no put option available to the seller, the seller can’t make plans, for example to move, to buy another property before the buyer is committed to complete the purchase
• the seller can’t agree to sell to a subsequent buyer who makes a more attractive and/or higher offer
• the market may change dramatically and suddenly – by far one of the worst possible outcomes.  If property prices were to fall, the buyer/developer may never exercise their option, so when the option period expires, the seller may have not only lost an opportunity to sell for a good price in a previously buoyant market, but the property’s value may have also significantly reduced

So, what to do?
My advice, particularly for a seller, is simply to ensure you really understand what option agreements are – they’re not all the same.

 

Know the advantages, disadvantages, as well as the possible consequences.  Realise it may not even suit your circumstances.

 

By far the best advice I can offer if you’re a seller approached by a buyer, a buyer’s agent, or a real estate agent, talking about options or delayed settlements, is don’t agree to anything, and certainly don’t sign anything, before you consult your own solicitor who will advise you and help you protect your interests.