Sunday, January 19, 2020

Options are Optional

You may think you know real estate options but until you've heard their nuances explained by Pete Fortunato you probably are not aware of the full range of their usefulness. Yesterday I and the pleasure of attending a lunch time seminar hosted by the good folks at self directed IRA servicer Advanta IRA. Pete is one of the real estate wizards residing in the Tampa Bay area. While he has spoken to groups of various sizes around the country he is not one of the gurus that spends his time on self promotion and course sales. He just quietly buys up more of St Petersburg every year.

First of all, neither Pete nor myself are lawyers. To my knowledge neither one of us has ever played one on TV. He regards them as soul stealers and I have found very little reason to argue with the exception of Ken Cuccinelli who once was my counsel and has gone on to bigger and better things. But before you go too far down the road of using options it would be a good to check with a real estate attorney who understands investors – especially if you are not working in the Sunshine State.

Let's start by defining a real estate option. It is the right to purchase a property at some time in the future for an agreed upon price. It an be a specific dollar amount or some other figure such as a percentage of appraised value or some other readily determined price. Being a legal agreement, the one who receives the option (the optionee) must give some sort of consideration to the property owner (the optionor). This can be dollars, personal property such as a car, or something else of value.

In the stock market you would buy an option on a stock if you anticipated that the price would increase and the seller would sell the option if they anticipate the stock holding is price or decreasing. While this is a perspective, real estate options are not quite so simple and the reasons people use them are far more diverse.

Some of the uses can best be understood through examples.

There may be a property you wish to purchase and the owner may wish to sell, just not yet. They may be induced to give you an option that can be executed anytime after a certain number of years have passed or after a particular event has taken place such as a resident no longer lives in the property. The purpose of this would be to give the optionee the right of first refusal when the property is no longer needed for its current purpose.

Options can be used to finance the repair or rehab of an income producing property. For example you own a rental property worth $120,000 and it needs a roof because the tenant is getting cranky about the raindrops that keep falling on his head. The problem is you don't have the $10,000 to pay the roofer. You could offer an investor an option to buy the property for $125,000 sometime in the next 10 years – perhaps after 5 years so you retain a suitable benefit.

What would this do. Your roof gets fixed. You keep the income and amortization, the tenant has a dry home and the optionee participates in the appreciation of the property value. What happens if the values don't increase as anticipated? That is the risk one takes when one buys an option, but the time period can be extended – for a fee – to help protect his investment.

The same can be done for someone in the neighborhood who has a roof, septic or other high dollar repair. In this case they would receive the fix and continue to enjoy the use of the home for the period agreed upon, such as while the kids are still in school.

In either case it would not be a greedy investor taking advantage of someone in a bind as some of our socialist politicians would want us to believe. It would be an investor solving someone's problem that they could not solve themselves.

Options can be used tactically as well. Pete told a story of this first real estate deal after he got his license. The house was sold for $20,000. Yes that's right. It's been a long time. The buyers came to the closing several hundred dollars short. This could have put the kabosh on the whole deal. They looked to the sellers who needed every penny to take to the next closing where they were buying their next home. They looked around the room and asked if anyone could lend them the money.

The attorney said that would not be possible since in their agreement with the banksters they said they would not be borrowing any down payment money. The speaker asked if they could sell something to raise the money. The attorney nodded. He offered to buy an option to purchase their house for $21,000 for the amount they needed to close. That was pretty much all of his commission, but the deal was completed. A few weeks later the buyers paid him they amount he offered and bought out the option.

The point here was that there was never an intention of taking over the property. The option was primarily security should things not go well. It was a tactic to accomplish a goal.

So what do options do? The things mentioned and so much more. It takes a little thinking and imagination. They give control and/or benefits of owning a property without the responsibility and expenses of ownership. They can be used to provide security in joint ventures. They can be used to solve problems. They can be used to provide financing when institutions don't see the benefit or understand the dynamics of an investment.

The thing is don't get so creative you go beyond what the law sanctions or protects. Speaking of protection, you may be wondering what keeps the optionor from ignoring the agreement and selling the property without your knowledge, consent or payment? Recording the option with the county clerk along with a mortgage will cause it to show up in title search. Title companies should do the job of keeping you covered. Be sure to record it again if they owners should refinance as they will most likely stop searching when they find the new loan in the first position.

Just a quick note if that last two sentences don't quite make sense. When you buy a house, you sign a note with the lender AND a mortgage agreement. Unlike popular terminology, the bank does not give you a mortgage. They give you a loan and you give them a mortgage which is the lien that is recorded in the public record along with the note. It's just a detail but recording the option and the mortgage puts a lien on the property. For non-lien states the terminology will be different but the principle is the same. That is why I suggested consulting a real estate attorney... a competent real estate attorney.