Epic Real Estate Investing - What You Might Not Know About "Options": Creative Real Estate Investing Continued... | Episode 206

Episode Date: May 23, 2016

Many real estate investors are familiar with options in theory, but how do they actually work in practice?  Today Matt is breaking down the option contract and explaining why it fits so nicely into the creative investor’s toolbox. ------- The free course is new and improved!  To access to the two fastest and easiest strategies to a paycheck in real estate, go to FreeRealEstateInvestingCourse.com or text “FreeCourse” to 55678. What interests you most? E.ducation P.roperties I.ncome C.oaching Learn more about your ad choices. Visit megaphone.fm/adchoices

You know how some people want to invest in real estate but they don't know how? Oh, yeah. And you know how some people want to invest in real estate but they don't have the time? Oh, yeah. And you know how some people want to invest in real estate and they simply don't want to do all that work? Oh, yeah. Do you know someone like this? Mm-hmm.

Perhaps that someone is you? Uh, yeah. If so, subscribe to the Turnkey Real Estate Investing Podcast, the show for Business. people who want to invest in real estate, but don't have the time or the desire to take on the heavy lifting. Turnkey real estate investing. Subscribe today. It's free. Yeah. Turnkey real estate investing. This is Terrio Media. Podcasting from Terrio Studios in Glendale, California, it's time for epic real estate investing with Matt Terrio. Hello and welcome. Welcome to

epic real estate investing the place where I show people how to escape the rat race using real estate. You just got to shift your focus from making piles of cash to making streams of cash, change that one thing, just one time, and you are on your way to financial freedom. Not very exciting, though. Uh-uh. Rather boring. Rather dull and boring, but it is the fastest path. And once you get there, then life then becomes exciting. And after all, it isn't that why we're in this in the first place? Yes, we're in it to create an exciting life. If an exciting business, yeah, that's awesome. But in exciting life, that's really what it's all about. And speaking of excitement, we're talking more creative, real estate investing today.

I love this conversation. So let's talk about another very useful tool that you can add to your toolbox of creative real estate investing. And that is the option, commonly referred to in conjunction with a lease, a lease option. I mean, they're so commonly referenced together that most don't even realize that they are two completely separate things. Yeah, a lease option is comprised of two entirely separate documents. They're two totally different agreements. And they can be used together as they frequently are or they can be used exclusively as, you know, or exclusive as individual documents.

So a lease, what's a lease? Let's cover that really quickly. It's a legal document. It's an agreement outlining the terms under which one party agrees to rent property from another party. So a lease, it guarantees the lessee, the renter, use of an asset, and guarantees the lessor, the property owner, it guarantees them regular payments from the lessee for a specified number of months or years of a specified period of time.

So with the lease as a real estate investor, you're going to most commonly use it to generate income from your properties with you being the property owner, right? That's when you're going to use the lease most of the time, is to get a tenant in place and generate income for yourself. and then the tenant or the renter is going to pay you for the property's use. Now, another way to use a lease to generate income is by you actually being the lessee. You can actually be the lessee, the renter, and still generate an income from a lease with the right, as long as you have the right to sub-lease the property out to a second lessee.

So if you rent the property for $1,000 a month and you find someone who is willing to pay $1,200 per month, what you've done is you've created a $200 per month spread of cash flow for yourself. Got it? So arbitrage. Rental arbitrage or lease arbitrage. It's pretty basic as to what a lease is and how to use it. And I only wanted to cover this just to demonstrate what it actually is and that it's a totally separate agreement than an option. So let's talk about the option. It's an option. It's a lower cost way to invest and profit in real estate. It's another entirely different strategy that actually not very many people talk about options all by themselves. So what is it? Well, an option is it's a, specifically designed contract between two parties. We got a buyer and we have a seller in this contract. And the seller offers the buyer the option to buy a property for a specified period of time at a fixed price. Okay. So the seller offers the buyer the option to buy the property.

They have the option to. It means they're not obligated to, but they can if they want. And in that option agreement, it's going to be at a fixed price and within a period of a fixed time. Okay. So the buyer purchases the option for the right to buy or not buy. the property during that specified time period. Now, in exchange for that right, what the buyer is going to do, the buyer is going to sell or pay the seller an option fee, an option premium. It's going to give them option consideration. You're going to hear it reference by all those different ways. A fee premium

consideration, whatever may be. So if the buyer decides to buy the property, in other words, exercise the real estate option, the seller must sell the property to the buyer according to the terms of that pre-existing contract. Got it? So, real estate options, they're most commonly used by property developers and investors in commercial or high-end residential property. But they can serve as a viable strategy and tool when putting together creative deals with all real estate in all capacities.

And what options do is they provide flexibility and a low-cost trading and investing opportunities to you as a buyer, as an investor. If the benefits actually to the seller, they're rather limited. Okay? So I'll give you an example of a typical real estate options trade. And we'll assume that, let's say you have your eye on a piece of property that's valued as is in its current condition. Currently, it's $250,000. And you go to try and purchase the property from the seller and they won't budge and they want $250,000 for their $250,000 property.

But that's okay. you can still make money on this deal because you've got bigger plans for this property. As you're thinking, wow, this property is, it's good enough size to where I can build two more houses on this property. And then I'm going to subdivide the property. And so ultimately when I'm done, I'm going to have three houses on three individual lots. That's how big this lot is. And I can sell each one of them at $250,000. But before you take that leap, you're unsure of a few things.

one, you don't have the entire $250,000 for the purchase, or do you even have the money for the rehab funds? And you're not sure where you're going to get it or whether you even can or can get it. Number two is you're unsure if you'll be able to get the necessary permits to build the properties, to build two more houses, and then you're unsure if the city or the county, whoever the powers that be in that area,

are even going to let you to divide the property into three separate lots. And the other thing is you don't even know if you're going to be able to raise the money and obtain the permits before someone else does and purchases the property. So you want to get control of it, right? Okay. So a real estate option, that would be an appropriate tool for this situation. So for a defined non-refundable cost called the real estate option premium or the consideration

of, say, let's say, $5,000. You can enter a real estate option contract with the seller. And what this option is going to do, it's going to allow you to secure the property at the seller's sales price of $250,000. So the seller's going to get what they want. month, but you're going to lock in that price for the next six months and you have the exclusive right. Whatever, or it could be six months, whatever term you agree to at the seller, we'll say six

months. So during this time, you can start raising money. You can start filing for the permits and you can start seeing if you can get the property divided. You can start doing all of your due diligence without the stress of someone coming in to purchase the property out from underneath you. You understand how that works? Very much the same strategy when it's.

comes to when I always say just get the property under contract. Get the property under contract. So now you can go in a relaxed environment, conduct your due diligence or market your property for a wholesale or something like that. And without anyone else being coming in to, you know, steal that property from you. And so that's the same concept, two totally different things. One's a purchase agreement. One's an option agreement.

The purchase agreement has an indirect implication that you are going to perform and close that deal. an option agreement gives you the right to, not the right, but it's implied that maybe you will, maybe you won't, okay, and for a much longer period of time. And also, you know, just as I've always said, when it comes to finding the money for your deal, it's, because that's, everyone's big issue, they're always hung up on that part,

where am I going to get the money to buy and invest in real estate? I don't have any money, so how can I do this? No, it's so much easier to find the money for your deal when you have control of the deal, when you actually have it under contract. And that could be a purchase contract or it could be an option contract. So through this option contract,

you control the deal for a certain period of time. You've got the price locked in as well. And you have the unpressured time to talk to investors, to talk to lenders, to talk to partners with something solid in your hands. Makes for much better and productive conversations, the type of conversations that actually result into something, not just big giant hypotheticals and big maybes down the road,

actually results into something because you got control of it. So now at the end of the six-month period of your option term, you're going to have a decision to make. One, you could exercise your right to purchase the property. And that would be your $250,000. You're going to go ahead and pay that and plus your $5,000 option fee. That's what the seller's got when you sign the contract. Or two, you have the option. I'm going to just go ahead.

I'm going to walk away and I'll surrender my $5,000 option fee. Or three, you can sell your option to another buyer. for whatever price you can negotiate. Either way, the seller makes an additional $5,000 on the sale or non-sale of the property. Now, in the real estate option contract, you're going to want to make sure to include the following. That option contract has to have a few things in it. One has got to have the property details, the location, the size, all the specifics of the

property. Two, it has to have the time period, the duration of the contract. Three, it has to have the premium or the consideration amount. That's how much the non-refundable amount that you're paying for the option. and it also has to have the fourth thing is the agreed purchase price, the price that you're locking in if the option is exercised during that contract period. So for the six-month duration of this example contract, there are four possible scenarios.

This is what can happen. Scenario number one, you find money to purchase the property and build the other two houses and you're able to get the necessary permits and you're able to divide the property and you can go ahead and complete the project. So what you do is you, instead of scenario one, you go ahead and you exercise your right to purchase at the agreed $250,000. That's scenario one. Scenario number two, after a few months, you discover you will not be able to obtain the permits to build,

but within the terms of your option contract, you're able to find another investor willing to purchase the property for $250,000. So you sell the option contract for a price of, say, $10,000. So you sell the option agreement. The new investor replaces you in the original option contract, and the new investor exercises the and purchases that property for 250 grand. Now, the seller receives $250,000 from the new investor, plus keeps the $5,000 option premium that you originally paid, but you sold the option for $10,000,

thus making a $5,000 spread there, a $5,000 profit for yourself. That's scenario number two. Scenario number three, let's say you're just simply an option buyer looking to benefit from the anticipated or speculated price appreciation of the property. you know, if the value of the property increases to 350 grand over the next six months, you know, let's say, perhaps you had, this is a common strategy, perhaps you had some insider information,

or just any information period, on a pending new highway approval, or a shopping mall approval, or you heard that some Fortune 500 company was moving into the area, thereby going to cause migration into the area. Or the school system was about to get a special designation, in which that typically always increases property values. You know, just about anything that causes property values to increase. One thing that I know one investor does,

they're always calling up and checking in with U-Haul to see where all of their vehicles are ending up, where all the one-way rentals are going. That's typically an indication of there's something going on there and people are moving there. And so that might be a good place for you to go out and start shopping for property values and purchasing options and waiting for the,

with the appreciation. All right. So anything that could cause property value to increase, the option buyer is going to benefit by exercising the option to purchase the property and then selling the property for $250,000 or purchasing the property for $250 and then reselling it for $350,000, netting a cool $100,000 profit, right? Well, $95,000 due to the $5,000 option fee they paid at front. Or instead of taking ownership and going through all that hassle and taking on all the expenses

of ownership, because all that could cut into your profit, What you can do is you can just simply sell the option to a new buyer. As the value of the property increases, so does the value of your option agreement. Okay? And then at the end of the transaction, again, the property owner is still going to get their 250 because that's what they agree to at front. Plus gets the $5,000 option fee because you pay that at front. And then, you know, you sold that option agreement, say, for $95,000

because the new buyer purchased the property at current market rate. Got it? So that's scenario number three. Scenario number four, you are unable to secure the funding and or you are unable to get the permit to build or you couldn't find a, you couldn't get the property divided, or you couldn't even find a new buyer for your option. So when the option period expires, you just lose the option fee. Okay, so you lost your five grand. But on the bright side, you were able to avoid a bad $250,000 investment. See how that works?

So in all scenarios, once the seller enters into it. real estate option agreement, the seller no longer has a say on whether to sell and at what price, because that's locked in. The seller must wait for the buyer's decision to exercise the option. This is why the seller receives and keeps the option premium up front. So that's how the option works. They offer a very, just, it's a very low cost, low risk method to trade, invest, and profit from real estate. However, they are, they are effectively over-the-counter contracts between two individual parties with no outside regulatory oversight. Like, no one's really watching this.

Okay, so it's up to you and the other party to ensure that the options contract is a fair one. Now, when an option contract goes bad, okay, so sometimes they go bad. And when they do, it's typically due to a default by the seller. And the seller might have a change of heart. They just change their mind. Or they got a case of envy over the profit

but that you're going to make on the deal. And that can sometimes present a challenge. So in such cases, really your only recourse would be a lawsuit. But by recording an option memorandum with county records when the option agreement is executed by you and the seller, you do this in order to position that agreement within the chain of title of the property. You see, when you do this, you've done a lot to secure your rights.

But still, a lawsuit may be the only, an ultimate remedy depending on the seller. Not to scare you, though. I'm not the type of educated that's always a warning of the terrible things that can go wrong. Because if you do good business and you're straight with people, there are many more things that, and they often do go right. There are many more things that can go right than go wrong, but you should always just

know the risks regardless of how minor or remote they may be. Okay. So now you know what an option is and how it works. It's another tool in your toolbox that can be used by itself or in conjunction. with all of the other tools you've been amassing over the last several episodes. You know, for example, you know, you could negotiate seller financing terms, seller finance terms within the option agreement. Or you can negotiate subject to terms inside that option agreement or both.

Say you agreed to $250,000. We'll just keep the price the same. The purchase price of this property. And the seller says, okay, I'll go ahead and I'll take $1,000 a month until the balance is paid off. Say that was all the terms. You can put those terms in the option agreement. but that's not going to be a really good deal for you unless you're able to get to rezone the property for whatever reason it may be so you go ahead and you put a six-month option in place

while you file for rezoning and then when you're rezoning or yeah your approval for that new zoning comes in then you can go ahead and you can exercise the option start making those thousand dollar payments to the seller but if that new zoning didn't come in then okay so you saved yourself some money and you don't have to exercise the option okay now Again, you're only limited by your own creativity. That's why it's called creative financing. And options, they're primarily a speculative investing strategy and a way to flip property with minimum risk

and actually really high profit potential as well. And they're best used, this is the most common scenario, they're best used for properties that meet the following criteria and or criteria. Properties that can be rezoned for a higher and better use. properties that are mismanaged, mismanaged rental properties that can be turned around, dirty fixer type properties that can be cleaned up and turned around,

or properties with functional obsolescence that can then be repurposed. Those are probably the four best criteria for an option agreement or introducing an option into your negotiating. So whether it's an option agreement, a subject to agreement, a seller carryback agreement, most people, they get stuck or they just mess up their deal due to poor explanations of these creative strategies to sellers.

It takes time to get good at clearly and eloquently explaining creative terms to sellers without confusing them or without alarming them. You know, especially if you're going to bring this up on the very first conversation with a seller, it's typically just too much for the seller to consume. So they're confused mind, it just shuts down and it says no, no. no thank you. So to work with this dynamic, because when I was getting started, I had very little money to my name of you all heard my story, that I was really attracted to all of these different

creative strategies. So I had to make these creative strategies work. But I started to recognize when I would meet with a seller and start introducing all these things. You know, I could just see their eyes rolling in the back of their head. And they weren't saying no because they didn't like the deal. They were saying no because they didn't understand. understand. So what I started to do is I started to implement the use of a three-option letter of

intent, three-option letter of intent. Not a contract. It's just saying, I intend to purchase or am willing to purchase your property in one of these three ways. So option one, always being my basic all-cash offer. Okay, so option one is always just a basic all-cash offer. And it's the one most easily understood by the seller. And if we got this far down the road to where I actually had to present this letter of intent, it was always because the seller had rejected that offer, that all-cash offer. It was just too low or for whatever reason. But I always include it in my three-option letter of intent. I always make that option number one so that the seller has it as a reference point to the other two options. That's why it's there. Option two would be a seller

financed option with interest-only payments. Okay? And then the third option would be a seller-financed option with principal-only payments. So I would do interest-only and principle-only. in this all cash thing because they all looked just very different on paper. So it looked like three complete. It looked like an apple and orange and a banana. Which one do you want? And so although it would be a huge win, for me, if the seller were to accept any of these options, typically they didn't accept any of these options.

They rejected all three of these. They didn't like any of them. So why did I continue to do it? Well, this is why I continue to do it. Because what does happen, what does happen is I notice that by presenting, in this option letter, this three option letter of intent, it got the seller's wheels to turn, to spin. And they started to come up with their own creative options. This started to be a a recurring theme that they would come back to me and counter offer with one of these options.

And boom, it was just like that. I was in the game. And you can be in the game with a creative strategy and a viable option, being on a viable option to acquiring another investment property. And it wasn't because it was your idea that you got. the deal closed, it was because it was the seller's idea, quote-unquote, the seller's idea. With the seller forgetting that it was your LOI that inspired their idea, you just got to go along with the game. If they want to claim ownership to that idea, I let them have it. So what this, the option letter of intent, it just consistently created conversations where there just wasn't going to be that conversation before. So now, when the seller comes back

with their creative option of selling their property to you, and if it doesn't meet your standards, now you can start introducing all of these additional creative ideas that we've been talking about, like subject to, like balloon payments, like the option. And now when you start presenting these different creative elements, you get a lot greater consideration by the seller. They start to like actually consider accepting your offer now. So the three option letter of intent, it can put the seller into the proper mindset to discuss a creative sale that wouldn't have been a possibility otherwise.

Does that make sense? So if you'd like a copy of my three-optional letter of intent, along with the calculator that I used to put it together, you can get it for free. Go to Epiclloi.com and pick it up for free. You can download it right there, boom, epiclloi.com, and start putting this to use in your business. You're going to do more deals.

You know, this is how you do more deals. Step one, you write more offers. write more offers. There's going to be a direct correlation between the number of deals that you do and the number of offers that you write. Okay, write more offers. The second way you get more deals

is you put more options within your offers. If you give them more options, they're more likely to have one of those get accepted. Okay? So that's what this tool is for. So start putting this use. It's only going to work for you if you use it. Okay.

So epiclloi.com, go get it. That's yours for free. I'll see you next week. I'm Matt Terrio, living the dream. You've been listening to Epic Real Estate Investing, the world's foremost authority on separating the facts from the BS in real estate investing education. If you enjoyed this show, please take a minute to visit iTunes and share your thoughts. Thanks for listening.

We'll see you next time here at Epic Real Estate Investing with Matt Terrio. This podcast is a part of the C-suite Radio Network. top business podcasts, visit c-sweetradio.com.