Real estate options are contracts that allow one side to purchase the right to buy the underlying real estate at maturity for a certain price on a future date, both determined in advance. Some of the benefits of entering into a real estate option contract are as follows:
- Considering the very large amount of money required to flip property, real estate options are useful tools to profit from real estate trading, which requires only a small amount of capital for the option fee.
- Individuals who do not have sufficient cash but wish to buy a house may purchase the real estate option, which allows them to lock in a price and gives them time to secure financing.
- Further, as options give buyers the right, but not the obligation, to buy the underlying, individuals (for instance, investors who want to purchase real estate for a shopping mall business) can take their time to evaluate zoning laws, conduct marketing research and inspect the land, with the assurance that they have fixed the price, in case they want to purchase the real estate in the future.
Real estate option transactions do not differ much from plain vanilla options that are traded in exchanges. An optionee (the buyer of the option) transfers an option fee (like the premium) to the account of the optionor (seller of the option) and, in return, purchases the exclusive, unrestricted, and irrevocable right and the option to purchase the property at a fixed purchase price during the option period. On the exercise date, the optionee can choose to either let the option expire worthless or exercise the option. Once the option is exercised by the optionee, the optionor becomes legally obliged to honor the terms and conditions of the contract and the purchase consideration must be paid to the optionor in full. If expired worthless, the optionor keeps the option fee and the optionee cannot claim this amount back.