Real Estate Acquisition Tips

Mutual Benefit Of A Long-Term Option

by Marvin Levin

A few years ago, my partner, Paul Menzies, and I owned a development parcel from Hell. It really qualified for the “Developers’ Nightmare Hall of Fame.” If you can think of a development problem, this property had it.

Of course, we wanted a buyer to complete due diligence in 30 days and then close in 30 days. The buyer wanted a free option for one year or more. Can you imagine buyer and seller being further apart?

To further complicate the split, the buyer complained that he would have to spend approximately $60,000 in due diligence-type expenses, including soil tests, survey, engineering and architectural studies, etc. He claimed that all of these expenditures would benefit the property.

Paul had a rather ingenious solution, which resulted in a closing about 10 months later. Both parties were happy with the result. He had suggested the following: The buyer pays over to us $5,000 each month for a 12-month option. The buyer could stop making the option payments at any time, and the option would terminate.

It was also agreed that the buyer could proceed with his schedule of tests, maps, etc. We agreed to pay for those tests from the $5,000 monthly payments received, without any obligation to pay out more than those payments. The tests would belong jointly to buyer and seller. If the buyer did not spend $5,000 each month cumulative, we would keep the unspent funds. Then, if the buyer did not exercise the option, the seller would retain the test results as his property.

It appears that this may benefit both parties. If the buyer does not exercise the option, the seller has tests that would make the property must easier to sell to another buyer in the future and, therefore, the seller might be able to shorten the due diligence time considerably. It also gives the seller a reason to give the buyer a longer exploration time, which the buyer may need for due diligence and to arrange financing. If the buyer drops the option, the buyer is out of pocket for the due diligence money, but is not out of pocket for the due diligence money plus an option payment to keep the property off the market.

The obvious win-win of the transaction described above is that in many cases a buyer may drop the option because he doesn’t have enough time. Frequently, a buyer obtains valuable tests, which he does not turn over to the seller, and that due diligence information sits on a shelf not doing anybody any good.

If you run into a situation that needs land financing, please contact me.