By NICOLE LEGGAT
Options are growing in popularity, as more sellers and buyers want flexibility and seek the confidence to invest time and money when pursuing a property deal before entering into a contract for sale.
How do options work?
Options come in two forms – ‘put’ and ‘call’.
A ‘put’ option grants the seller the right to compel a buyer to buy their property. A ‘call’ option, on the other hand, is the reverse of a ‘put’ option; it gives the buyer the right to compel a seller to sell the property to them. Together, a ‘put and call’ option grants both parties the right to require the other to buy or sell the property.
Options are created by written agreement. Such an agreement will outline the terms upon which the parties may exercise their option. The contract for sale will be included as an annexure to the agreement and this contract is only entered into upon exercise of the option.
The option agreement will specify an ‘option period’, which is the amount of time that the parties to the agreement have to exercise their option rights. The option agreement will also set out the procedure that needs to be strictly followed to exercise the option. Purporting to exercise the option in a manner that’s not strictly in accordance with the terms of the agreement may result in rejection by the other party.
When an option is exercised, the parties enter into a binding contract for sale, and the purchase of the property is as per the terms and conditions set out in the contract attached to the option agreement. If an option is not exercised during the option period, it will lapse and the parties are freed from their obligations.
When are options used?
Put simply, ‘put and call’ options work to postpone the creation of a contract for sale, but still bind the parties to the deal.
Options are commonly entered into when the parties want to:
- Incur a lower upfront cost (as an option fee is generally less than a 10 per cent deposit)
- Delay the obligation to pay stamp duty on the contract for sale
- Delay the disposal of property (as a capital asset) to a later tax year
- Enable a developer additional time to purchase adjoining properties.
What are the positives and negatives?
The primary benefits of using a ‘put and call’ option agreement (rather than a usual contract for sale) are the potential savings. For example, savvy property investors may take out options on several properties, apply for development consent on those properties and then sell them to an independent third-party developer. Subject to the nomination duty, the costs for the investor to do this are kept to a minimum.
On the negative side, ‘put and call’ options are complex and involve more time and legal expense in their preparation. In addition, some property owners may be reluctant because it all seems too complex, resulting in extra negotiation time and additional legal fees. A further risk is that the seller may end up missing out on any extra profit that comes from a higher sale price than originally agreed if the market increases.
If you’re considering a ‘put and call’ option for a client, you should carefully consider current market circumstances and how long the option should extend. If the market shifts considerably, a seller may be left out of pocket if the negotiated price for the property at the time of entry into the option agreement ends up being more than the sale price at the time the option is exercised.
As an agent, you should also consider tailoring your agency agreement to state that your commission is payable upon entry into the option agreement in order to secure your fees. If you don’t, commission will only become payable upon entry into the contract for sale.
NICOLE LEGGAT is from NL Legal.