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Option Contract Real Estate: How They Work

Updated: August 11, 2023
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Are you considering selling a high-end or investment property? Then, attract top-tier buyers by creating nearly irresistible terms and conditions. One such way to support this objective is by offering an option contract in real estate.

Find out what sellers and buyers need to know about real estate option contracts.

What Are Option Contracts in Real Estate?

Option contracts in real estate, also known as “option to buy” contracts, purchase and sale agreements, or real estate purchase agreements, are legal contracts that grant a buyer or investor the right to purchase real estate from a seller. The seller typically offers an option to buy a property within a limited period. An option contract in real estate ensures that the buyer has exclusive real estate purchase rights.

In addition to exclusivity, the buyer is under no obligation to follow through on the purchase. A seller is also not required to reserve the property indefinitely. Once the time limitations expire, buyers lose their purchasing rights, and sellers can offer others the option to buy.

This article also explains option contracts in real estate.

What is the Purpose of an Option Contract?

The purpose of an options contract in real estate is to offer the buyer alternatives. Outcomes may vary according to the type of buyer, including early exercise, option expiration, or second-buyer sales. Real estate professionals use option contracts to provide flexibility on specific types of real estate transactions.

In addition to flexibility, the purpose of option contracts in real estate includes:

  • Purpose 1. Attracts high net worth buyers to high-end real estate transactions
  • Purpose 2. Provides stipulations in purchase agreements , land contracts , a deed of trust , and mortgage notes
  • Purpose 3. Lowers the costs of the initial investment
  • Purpose 4. Depreciates the real estate without actual ownership
  • Purpose 5. Mitigates seller risks on EPA liabilities
  • Purpose 6. Allows optionees to do a 1031 Exchange without actual ownership

The bottom line is that real estate options contracts offer an alternative form of investment, trade, and profit over traditional opportunities. An exchange market for options doesn’t exist, but their provisions may increase the future likelihood of that happening. The most vital aspect of writing an options contract in real estate is that they are enforceable and valid.

Here’s another article about options contracts in real estate.

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Examples of How Option Contracts in Real Estate Work

The most common example of how option contracts in real estate work is developer use. Let’s say that a developer wants to purchase a $3 million building but cannot secure funding for up to one year. Since there’s no point in obtaining financing on a building that may not be for sale in a year, real estate option contracts allow the developer to get exclusivity rights.

Conversely, commercial property is challenging to sell from the seller’s perspective, depending upon location, market, size, and other factors. The building could sit vacant for years in this scenario due to its unique purpose. Instead of waiting for a solvent buyer to come along, which is rare, an option contract in real estate provides reasonable reassurance that the property buyer is sincere and earnest about their desire to satisfy the sale terms and transfer the property.

Assignable Purchase Option Contracts

Assignable purchase option contracts are a specific type of real estate option agreement. The assignable purchase option transfers and grants assignments to another party. This process is known as the contract assignment, and they’re used when one party wants to directly transfer real estate assets to the assignee.

In this situation, assignees receive the benefit of the property acquisition under the original purchase terms. However, they must also understand that they’re taking on the assignor’s duties, responsibilities, and liabilities.

Key Terms Included in Real Estate Option Contracts

Getting the terms and conditions right in a real estate option contract is the most vital aspect of protecting your seller’s rights. They also define the particulars of the contract so that all parties are on the same page with each other. Ensure that you write your option contracts in real estate with simplicity and clarity to avoid confusion or a misunderstanding in the future.

Here are the key terms included in real estate option contracts:

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Key Term 1. Option Fees

Option fees are used in the commission of contract enforceability. For a contract to be valid and enforceable, something of consideration must exchange between the buyer and seller. The option fee cannot be nominal, but there’s no specific guidance on reasonability.

It’s also worth noting that option fees are non-refundable. Therefore, if the buyer doesn’t want to exercise their purchasing rights, they generally forfeit the option fees. However, if the buyer follows through on the purchase, the seller typically deducts the option fee from the sale.

Key Term 2. Duration

Real estate option contracts must also specify a date by which they have to exercise their purchasing rights. There is considerable flexibility in this term since sellers can allow them to continue for weeks, months, or years. The standard range by which most sellers follow is between one and five years.

Buyers have the opportunity to purchase the real estate asset at any point during the option period. However, if the period expires, the agreement terminates, and the buyer loses option fees paid to the seller.

Key Term 3. Real Estate Purchase Price

Option contracts in real estate must also include the purchase price of the asset. The value is based on the property’s current appraisal value. However, this strategy doesn’t always seem sensible, especially for more extended option duration periods.

In most cases, sellers require that the buyer agrees to a reappraisal of the property. Other issues may include the seller simply agreeing to sell at the current market value. Regardless of the method, the most critical aspect for enforceability is that everyone agrees and is amenable to the terms.

Key Term 4. Choice of Law Clause

Some states have specific statutes surrounding option contracts in real estate. As such, you should ensure that your agreement includes a choice of law clause and complies with the mandated rules.

A choice of law clause allows you to specify what rules your agreement will follow. In many cases, it is based upon where the property is located.

Who Uses Real Estate Option Contracts?

Real estate investors and developers most commonly use real estate option contracts. The flexibilities and advantages they provide make them an excellent buying opportunity while limiting seller benefits. Buyers, assignors, and assignees are usually the receiving parties of option contracts in real estate and sign them alongside the seller.

Are Real Estate Option Contracts Required to Be in Writing?

Yes, real estate option contracts are required to be in writing. The reason for this requirement is that they must comply with the Statute of Frauds (SOF). SOF transactions must contain key elements to be legally binding and enforceable.

It’s easy to make legal mistakes with option contracts in real estate due to their complexity. These mistakes could result in unwanted or unintended financial and legal consequences for you in the future. The most practical approach toward writing a real estate options contract is seeking legal advice from real estate lawyers in your state.

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