How to Make Money with Real Estate Option Contracts

A real estate option contract, also sometimes called an option to buy, is a legally binding document between a buyer and seller that gives the buyer exclusive rights to purchase the property at an agreed upon price within a specified time period.

Here's how it typically works. A buyer will give the seller an agreed upon, non-trivial, sum of money (usually 1-5% of the purchase price) in exchange for the exclusive right to purchase the property within a specified time frame, usually 6 - 12 months, and for an agreed upon price, usually the current market value of the property.

When an option contract is signed, the seller cannot sell the property to anyone else until the contract expires. The buyer may exercise the contract at any point and force the sale of the property at that time. However, the buyer is not obligated to purchase the property and can walk away from the deal at any time or let the contract expire. If the buyer chooses not to purchase the property, the seller will keep the option fee that was paid by the buyer when the contract was signed. If the buyer does purchase the property, the seller will sometimes apply the option fee towards the purchase price.

Option contracts are a unique way to purchase property and it gives the buyer several distinct advantages and opportunities traditional purchasing methods can't provide.

Perhaps the biggest advantage of investors gain from real estate options is the ability to control a property without ever owning the property. This means you can negotiate large deals with limited risk and avoid all the headache of obtaining financing, paying realtor fees, and the other hassles involved with owning a property. Instead, with real estate options you have the exclusive right to purchase a property and you can assign or sell your right to purchase to another party. This means you can profit from real estate transactions without ever owning the property.

Let's look at a few examples of how to make money with real estate option contracts.

If an investor expects a property to appreciate in value in the near future, they may use an option contract to tie up the property and ensure they have exclusive rights to purchase it. Then the investor waits until the property value increases, at which time they can buy the property and resell it for a higher price, or they can sell the option contract to another buyer.

Selling the option contract is a great choice if the buyer is looking for a way to make a profit but doesn't have the funds to buy the property outright. An additional advantage is that the option contract limits the buyer's risk. If the buyer purchases an option contract and the property doesn't appreciate, the buyer is not obligated to purchase the property. They can walk away from the deal losing only the money spent on acquiring the contract. Losing a few thousand dollars from a bad option contract is a much lower risk situation than losing tens or hundreds of thousands of dollars by purchasing a property that declines in value.

Undervalued properties make great candidates for option contract investors. Specifically, I'm talking about properties that are vacant, vandalized, filthy, have title problems, used to be meth labs, or have other problems that scare away typical real estate investors. Properties like this can often be purchased at a steep discount, then with a little cleanup and a little marketing, they can be resold to a buyer or another investor. Often, the really good deals for option contracts, aren't listed for sale on the MLS. Instead, it takes some work to find the right property, track down the owner, and negotiate a deal with them.

Properties in distress are also a good pick for option investors because the property owners are more likely to be motivated and may be more likely to sign an option contract.

When dealing with option contracts it's recommended to keep the option fee below 5% of the agreed upon purchase price, and do your best to negotiate a purchase price that is at least 20% below market value. Following these simple guidelines helps ensure the deals you make will be profitable and will be worth your time.

Another option available to investors is rezoning properties. Rather than waiting for a property to appreciate or dealing with distressed properties, an investor can purchase an option contract for a property that is zoned as low value property type and then attempt to increase its value by rezoning it for a more profitable use. For example, if you can get the city to rezone a property from low-density residential to commercial you may significantly increase the resale value of the property. At which time you can use your option contract to purchase the property at the previously agreed price and then resell it to a commercial builder for a much higher price. Rezoning is not an easy task, it takes a lot of time, and you may have to navigate through a lot of red tape, but it is clever way to make a considerable amount of money quickly and with little risk.

One of the most common ways option contracts are used is with large commercial real estate deals. Sometimes a buyer will want to purchase a property, but they need more time to acquire funding or to finish other projects first. In these scenarios, they can use an option contract to ensure that no one else can buy the property they want. Later, when the have the time and money to purchase the property, they can do so. This is a great way to make sure they can get the property they want. Option contracts are a great tool to ensure that builders and investors don't miss out on a great deal or a great location.

We have covered four of the best ways to make money with real estate option contracts. If you find the right deal, option contracts can create low-risk, high-reward investments. However, to make these deals work you need to be sure and do your homework first. There is no substitute for thorough research. In the business of real estate investing, it is critical that you verify all the information you are given and that you perform proper due diligence including title and property inspections before you shell out any money or sign any contracts. Additionally, note that it is almost always a good idea to hire competent professionals to assist you with any areas you lack expertise. It is highly recommended that you hire a qualified real estate lawyer who is familiar with real estate option contracts to help you write up the necessary contracts and avoid any legal loopholes or pitfalls.

When used wisely, option to buy contracts are an incredibly effective tool to help savvy investors make large profits with little risk and little capital.