Options in Development – Part 4 – Examples

Over the past three articles from Andrew Pine lawyer, we have discussed the different forms of Options. We have explained the reason why an Option Fee is often required. We have also uncovered what a Due Diligence clause is and how it protects a Buyer. We have then discussed how a Security Deposit functions. Finally we have explained when a Development Approval clause may be required.

Andrew Pine lawyer will now outline a couple of real-life examples used in the property development world. This should provide you with a practical understanding of how an Option functions and also how it can be used to benefit you from a legal and financial perspective. As has been continually explained to you throughout this series – you must obtain legal advice tailored to your specific circumstances before engaging in any form of Option arrangement. It is essential that you do not sign any Option documentation before obtaining this tailored legal advice. Andrew Pine solicitor can advise you on Option Agreements and can be contacted on the details found at the bottom of this article.

Finally, these real life examples should only be considered as examples. They are not legal or financial advice as to how an Option arrangement should be structured. They are solely used to explain how an Option agreement may be structured. This is to solely provide you with an understanding as to how the mechanics of an Option can function. Please do not rely on these examples without engaging a suitably qualified solicitor and accountant.

 

Example 1 – A Call Option with a Due Diligence Condition

James owns a large ‘old Queenslander’ in Brisbane. He is about to put his house on the market. An investor approaches him offering to pay him the market value of his property ($700,000), thereby avoiding the need for James to pay Agent’s commission.

The catch is that the investor wishes to determine what he can rent each room out in the house for before committing to a Contract to buy the Property. The investor will take two weeks to determine this and he can then commit to the deal. As this is not a long period of time, James agrees to this arrangement. The investor will then have a further three weeks to discuss this purchase with his bank to ensure he can borrow enough money to buy the property. After which the investor must either commit to purchasing the property at the fixed price by signing an unconditional contract, or walk away.

What is one way this deal could be structured?

One way this deal could be structured is by way of a Call Option with a Due Diligence condition. Firstly an Option Fee could be paid by the Buyer to the Seller for giving the Buyer a right but not the obligation to purchase the Property. This is likely to be a smaller amount, given the Option will not be for very long. The Buyer may then have a Due Diligence clause giving it two weeks to determine what it can rent each room out for so as to clarify whether the investment will be a good one. Once this Due Diligence Period ends, the Buyer could then have a further three weeks under the Call Option Period to determine whether its bank can lend it the requisite funds. If the bank cannot, the Buyer can therefore elect to not exercise the Option, thereby allowing the Call Option Period to expire and the Option now being over. The Buyer is not forced to purchase the Property as there is no Put Option.

This is of course one of many ways this deal could be structured. Again, please do not structure deals without contacting a solicitor suitably qualified to advise you on Options. Andrew Pine lawyer is an experienced solicitor who can advise you on Options and your circumstances.

 

Example 2 –  A Put and Call Option Agreement with a Security Deposit and a Development Approval Condition

Sandy owns a vacant piece of land. She is considering selling the property but is not in a hurry. A developer has approached her and wishes to purchase her land for $700,000.00. Sandy is ecstatic as her land is only worth $650,000.00 at the current market rate. The developer is only willing to pay a price over the market rate because he can see the potential in subdividing the land (a form of development). This will take some time to confirm with the local council and the developer wants to ensure he is not forced into buying the land if the local council does not approve his request to subdivide the land.

The parties have agreed to enter into a Put and Call Option Agreement with a Development Approval condition.

The developer could therefore pay Sandy a small Option Fee (let’s say $1,000.00) for her signing the Option Agreement. This Fee is non-refundable so Sandy can spend it now if she likes. The developer may also pay Sandy a $10,000.00 Security Deposit at the same time. If the developer proceeds to buy the land, the $10,000.00 forms the deposit so is part of the price paid ($690,000.00 would therefore be due at Settlement rather than $700,000.00). The developer could then have a certain period of time (often at least six months) to contact the council and obtain development approval from it to subdivide the land how the developer wishes. This is called a Development Approval clause. During the Development Approval Period, the developer is able to terminate if it does not receive satisfactory development approval. It may (or may not, depending on how the Option is structured) be entitled to receive the $10,000.00 Security Deposit back from Sandy if it terminates the Option under this Development Approval condition.

Should the Development Approval condition be satisfied, the Call Option Period may still have a period of time to run. During this time, the developer may exercise its right to purchase the land. If it does not exercise this right by the end of the Call Option Period, the Put Option Period will then commence. Sandy will then have the right to force the developer to buy at the fixed Price.

This are numerous examples of how this arrangement could be structured. You must not enter into Options without contacting a solicitor experienced in Options. Andrew Pine solicitor can advise you on Options and draft any form of agreement you require.

 

The above two examples show how Call Options and Put & Call Options work with Due Diligence and Development Approval conditions. The above two examples also demonstrate how Call Option Fees and Security Deposits function. You must not substitute these examples for financial and legal advice.

 

Disclaimer: Andrew Pine is a property solicitor practising in Queensland. Andrew is not qualified to give accounting or financial advice. This article is written solely as an opinion of the writer. This article should not be relied upon for legal, accounting or financial advice. You should always seek advice which is tailored to your individual circumstances.

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Options in Development – Part 3 – Terminology (2)

This article builds on our previous discussions regarding the terminology used in the option sphere. You are now aware of why a Seller requires an Option Fee. You are also aware of how a Due Diligence period works. Today we will build on this knowledge by discussing the Price, Security Deposit and Development Approval conditions. In our final article in this series from Andrew Pine lawyer, we will put this information together to run through examples of how options work in the real world.

As has been outlined throughout this series – these articles should not be substituted for legal advice. You should never enter into an option of any kind before discussing this matter with a lawyer. Andrew Pine solicitor acts for numerous clients who regularly enter into option agreements. Andrew Pine lawyer can therefore be contacted on the details contained in this blog should you wish to receive legal advice that is tailored to your personal circumstances.

 

Price

When a Buyer enters into a Call Option Agreement (or a Put & Call Option Agreement which is conditional on Due Diligence and/or Development Approval) they are obtaining the right but not the obligation to purchase the property. As discussed in our previous article from Andrew Pine solicitor, the Buyer will usually pay an Option Fee to the Seller for obtaining a right which does not come with a corresponding obligation to buy. More importantly, the price payable if the Buyer elects to proceed with purchasing the property must be agreed between the parties at the outset.

Because the price is fixed from the beginning, the Buyer wields a lot of the power. After signing an Option Agreement with the Seller they could contact other parties (such as developers) and obtain a price which is higher than that agreed to with the Seller. The Buyer could then assign its rights under the Option to the third party for the margin (the difference between what the Buyer is obliged to pay the Seller and what the third party is willing to pay for the property). This process can often be carried out without the Buyer having to pay transfer duty as the Buyer usually never owns the property at any point in the transaction.

The price agreed to between the parties is payable at Settlement. However part of the deposit can be paid beforehand, usually as a Security Deposit. Andrew Pine solicitor is experienced in advising a wide array of people dealing in Option Agreements. If you would like advice on options, please contact Andrew Pine lawyer on the details provided at the bottom of this article.

 

Security Deposit

Under a usual Contract to purchase a property, a Buyer pays a deposit to the Seller to demonstrate that they are genuinely interested in purchasing. Any deposit they pay is attributed towards the purchase price, leaving the remainder payable at Settlement. The same is often true with Option Agreements. A Buyer under an Option usually pays a Security Deposit to the Seller, with this amount being subtracted off the price due at Settlement. How much is paid, when it is paid and whether these amounts are refundable should the Buyer elect not to proceed with purchasing the Property are all up for negotiation between the parties.

It is however common for part of a Security Deposit to be payable up front (at the same time as the Option Fee is payable). Another part of the Security Deposit may then be due when the Buyer confirms to the Seller that it is satisfied with its Due Diligence enquiries and/or it has obtained satisfactory Development Approval (if relevant). As noted above, any Security Deposit paid is then attributed towards the price payable at settlement, rather than an Option Fee which is merely a fee paid by the Buyer to the Seller for entering into the Option Agreement.

It is essential that you obtain tailored legal advice regarding Option Agreements and Security Deposits. Andrew Pine solicitor can advise you on these items regarding your individual circumstances. You can contact Andrew Pine lawyer on the details below.

 

Development Approval

Many Buyers enter into Option Agreements because they see the potential in the Property. The Property may have potential to be subdivided into smaller Lots, or be amalgamated with adjoining properties to form one bigger Lot. Alternatively, the Property could be changed from fee simple (free standing land) into strata (apartments or townhouses). Whatever the reason, Buyers may make an Option conditional upon them receiving a development approval application which is satisfactory to them.

As Councils quite often require the owner of a property to sign development application documentation, a good Development Approval condition in an Option will require the Seller to sign any development application documentation the Buyer puts in front of them.

It is also essential that the Development Approval clause gives a Buyer enough time to obtain the approval. Some councils can take extended periods of time in approving various forms of applications so it is important you check with your town planner as to how much time you will need.

Development Approval clauses are difficult and you should engage a lawyer experienced in Option Agreements. Andrew Pine solicitor is a lawyer experienced in advising clients on Option Agreements and Development Approval clauses. Andrew Pine lawyer can be contacted on the details found below.

In our next article we will wrap this series together by reviewing examples of Buyers and Sellers entering into Option Agreements.

Disclaimer: Andrew Pine is a property solicitor practising in Queensland. Andrew is not qualified to give accounting or financial advice. This article is written solely as an opinion of the writer. This article should not be relied upon for legal, accounting or financial advice. You should always seek advice which is tailored to your individual circumstances.

Options in Development – Part 2 – Terminology (1)

As you have already read “Options in Development – Part 1 – what is an option and what forms of options are there?”, you are now familiar with what Call Options, Put Options and Put & Call Options are. There is however a plethora of terminology thrown around in the circle of options which you may need to get your head around if you are to wheel and deal in this arena.

This article and our third article builds on the previous discussion of what an option is by explaining some of the common language used by option traders and property developers. Our fourth article from Andrew Pine solicitor will then tie in these first three articles and discuss how they often function in the real world. These articles do not however substitute for legal advice and you should obtain your own, should you wish to engage in any form of option documentation. Andrew Pine lawyer is experienced in option agreements and can advise you on any option queries you may have. Andrew Pine solicitor can be contacted on the details provided at the bottom of this article.

 

Option Fee

You have probably been wondering throughout this series so far- why would a Seller give the Buyer a right but not the obligation under a Call Option Agreement to buy their property for a fixed period of time at a pre-determined price? If they gave a Buyer this ability without anything in return, they would essentially be giving the Buyer a free kick to potentially buy the property under the market rate. A Buyer would be able to sign up an Option Agreement with a Seller and wait to see if the market value increased above whatever price is agreed, then essentially buy the property for this fixed price which may be below market value. If the market went up, happy days. If the market did not, the Buyer could just walk away. Well here’s the catch.

The Seller often (but not always) requires the Buyer to pay an Option Fee. This fee can either be payable when the Option Agreement is entered into, or over a period of time or when certain milestones are reached. The amount of this Option Fee can be either a high amount or a very low amount, as this is a commercial negotiation to be agreed upon between the parties. If the contract to purchase the property is entered into (either by exercising a Put Option or Call Option), the Option Fee does not necessarily form part of the Price paid by the Buyer to the Seller to buy the Property. It is a separate fee paid for entering into the Option Agreement – i.e. for the Seller giving the Buyer the right but not the obligation to purchase the property at a particular price.

Another aspect of an Option Fee which is up for negotiation is whether these funds are refundable should the Buyer not proceed with exercising its Call Option. As a Call Option Fee can quite often be viewed by Sellers as compensation for the Seller being forced to sell at a price which is locked in, Sellers usually require this amount to be non-refundable so that if the Buyer walks away, the Seller has at least something to show for the inconvenience of entering into an arrangement which ties up the property.

It is however worth noting that Put Option fees may also be payable in the reverse. Given the Buyer may be forced by the Seller to purchase at a particular price, the Buyer may require a certain level of compensation, such as a Put Option Fee.

Finally, Option Fees often incur stamp duty (transfer duty) payable by a certain date. Given there are a plethora of considerations to take into account with Option Fees, it is essential that your lawyer drafts an Option Agreement and gives you advice prior to you signing it. Andrew Pine solicitor can be contacted to draft and advise on Option Agreements.

 

Due Diligence Period

After an Option Agreement is signed up with a Call Option Period (it may even include a Put Option Period), the Buyer may want some further protection – a Due Diligence Period. This gives the Buyer a certain period of time during which it can conduct any investigations of the Property it deems necessary. For example, if the Buyer intends to build a house on the land, a builder may wish to investigate whether one can even be built! The Buyer may also need an Agent to investigate what similar properties in the area are selling for in order to ensure they are buying the Property for a price that works.

In essence, there are an unlimited number of investigations a Buyer can make during a Due Diligence Period. This period usually runs from shortly after the Option Agreement is signed for a fixed number of days by which it is agreed that the Buyer should be able to know enough about the Property to decide whether it wishes to continue with the Option Agreement. If the Buyer does not wish to proceed, it is able to terminate under Due Diligence.

A Primary reason for a Buyer requesting a Due Diligence Period in an Option is where you not only have Call, but where there is also a Put. If an Option Agreement is solely a Call Option, the Buyer could pull out at any time. However, where the agreement is a Put and Call Option Agreement, should the Buyer wish to not exercise their Call, they often cannot terminate, so the Seller may then force the Buyer to buy the Property under the Put Option. Due Diligence is therefore one way the Buyer can terminate should they wish to pull out. Should you wish to discuss any aspect of Due Diligence, Andrew Pine lawyer can advise you on how to protect yourself with drafting an adequate provision in the Option Agreement.

 

The above serves as an introduction to the terminology of Option Fees and Due Diligence. This article does not however substitute for legal advice. It is vital that you obtain legal advice tailored to your circumstances. Andrew Pine solicitor can advise you on Option Agreements with regard to your personal situation.

In our next article we will focus on a Development Approval clause and what is a security deposit. In our fourth article Andrew Pine lawyer will then delve into real-life examples, once the terminology has been explained.

 

Disclaimer: Andrew Pine is a property solicitor practising in Queensland. Andrew is not qualified to give accounting or financial advice. This article is written solely as an opinion of the writer. This article should not be relied upon for legal, accounting or financial advice. You should always seek advice which is tailored to your individual circumstances.