It should go without saying two of the most important benefits that the option contract offers to the investor is that it allows the investor to take the property off the market and lock in a sale price. This means that any appreciation in value will be to the benefit of the buyer.
Many astute investors will buy properties on an options contract at their full market value, but on a long-term option contract, because they foresee significant appreciation in value.
Example: Using Option Contracts to Reap Appreciation
Larson Development wants to lay the groundwork for future projects. It approaches Farmer Jones to obtain an option to buy his huge farm located near the Interstate. Farmer Jones isn't ready to sell, but he does need money to make up for a bad year. Larson Development appraises the farm for about $1 million; however, they offer Farmer Jones a contract price of $1.1 million. In addition, they offer Farmer Jones a non-refundable option fee of $100,000, which will be credited toward Larson Development's purchase price if and when the developers exercise their purchase option.
Nine years later, the property is worth $2 million. Larson Development can now easily go to the bank and get a 50% LTV refinance loan to get the $1 million they need to pay off Farmer Jones and acquire the property.
But Larson Development has an experienced finance manager. By the time the company is ready to buy the property, they have also put together their development plans. Larson Development plans to subdivide the property into 300 lots. The total cost of this subdivision (survey, grading, legal subdividing, bringing in water & sewers, street paving and basic preparations) will be about $1.5 million. However, the total value of the subdivided farm will be $6 million. Larson Development then applies for and receives a 50% LTV loan of $3 million. This is enough to pay the $1 million sale price to Farmer Jones and the $1.5 million cost of the subdivision; the $500,000 surplus cash from the loan will go to Larson Development.
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