Option in the stock market is obvious, but does option for real estate works?

Quite frankly, unlike in United State, the option for real estate is not popular in British Columbia in Canada. 

 

A real estate option is the right for the buyer to purchase a property for a set price before the expiry of future date, whereas the seller is obliged to sell for the set price before the expiry date.

 

However, I strongly suggest that you should discuss the enforceability of option agreement with lawyer (not realtor) before you pursue this strategy. 

 

How the strategy works?

  1. find the property and make an option offer
  2. if the seller accept, pay some cash premium to the seller.  Enter to a valid option agreement that give you the right to buy the property at fixed price before a certain expiry date
  3. When market value increase, you can either buy the property at a later date (which allow you a cash profit), or sell/assign your option to another buyer.  Make sure the option agreement allow you to assign your right.
  4. When market value decrease, you don’t need to exercise your right, all you lose is the cash premium

 

Why the seller agrees to the option agreement?

Yes, sellers are not dumb, but option agreement is advantages to them when

  1. The sellers want cash premium. 
  2. They don’t expect market value go up.   If market value goes down, they earn all the premium because you won’t buy a property at a price above market.
  3. Even market value go up, they are obliged to sell at a predefined price acceptable to them when they sign the option contract.  This is a win-win situation for both buyer and seller.

 

Remember, to be successful in this strategy, you must:

 

  1. negotiate the strike price of the property below market value. 
  2. (strike price + premium ) should be below the market value
  3. market your property to find a buyer.  Target to resell / assign before expiry date at a price above (strike price + premium ).  Otherwise, you lose your premium

 

Advantage of using option:

  1. you don’t need o qualify for a mortgage
  2. you don’t own the property, and no need for closing cost, property transfer tax, insurance, maintenance, mortgage payment
  3. you got relatively small amount of cash tied up for cash premium
  4. you tied up the property at a  fixed price

 

Disadvantages of using option

  1. similar to stock option, if you don’t exercise your option, it expires worthless and you lose all your cash premium
  2. Buyer of the option could be sceptical to the validity of your option contract, and need to consult their lawyer.  It’s more complicated to market a option contract then a real estate.
  3. Seller of property usually refuse to give you option because if they want quick sale for cash.  (You may want to try out to see the seller’s motivation)