Put and Call Option Agreements in Property

A put and call option agreement in property can be a powerful tool in the hands of a sophisticated buyer.

But how do put and call option agreements work in practice, what are the legal foundations for them, and what are some traps to watch out for as a buyer looking to utilise this legal mechanism for profit?

What is an Option in General Terms?

You may have come across the idea of options before. They can be used in a corporate setting, as well as in share transactions.

In property, an option is where the buyer pays a fee to the seller to secure the right to make the seller sell the property at a given time, on given terms.

So, for example:

You are selling a block of land;
We agree that any time for the next year, I can make you agree to sell me that land on agreed terms for a purchase price of $400,000, during which time you can’t sell it to anyone else;
I pay you a $10,000 fee for that right.

This is a straightforward type of option.

What Do the “Put” and “Call” Options Mean?

In property transactions, our options tend to get pared into two parts:

A “call” option – this is the right in the hands of the buyer to “call” for the property to be sold to them; and
A “put” option – this is a right in the hands of the seller to make the buyer purchase the property.

Usually, the buyer has the right over a longer period of time to exercise their option, and the seller can only force the purchase if the buyer fails to.

So, if, in our simple example above, we inserted a put option, we would end up with something like this:

You are selling a block of land;
We agree that any time for the next year, I can make you agree to sell me that land on agreed terms for a purchase price of $400,000, during which time you can’t sell it to anyone else;
I pay you a $10,000 fee for that right;
If I do not exercise my right to buy the property within that year, you can give me a notice within 14 days after my option expires and make me go ahead with the transaction.

The reason for this is relatively obvious. The option is generally more beneficial to a potential buyer, so the potential seller (who is giving up their right to sell to anyone else for the next year) needs some comfort that they won’t be left dry and high at the end of the timeframe.

After all, option periods can be a fairly long time, and in a volatile market a lot can happen over that time.

What if you are a property buyer and don’t want the risk of being compelled to buy the property (that is, you want the call but not the put)? Well, if you can convince the seller at all, you should expect a higher price for the option fee since their risk will be higher as yours gets lower.

When would you use a Put and Call Option Agreement in a Property Transaction?

So knowing what a put and call option agreement is and knowing when to use it are two separate things.

As a buyer, there are some main benefits:

Locking in the deal while you get your ducks in a row. Perhaps this is a great and timely deal for you, but you’re not quite ready to execute in terms of finance, structuring, development approval or the like. The option can secure your deal while you line things up.
Due Diligence – as a buyer, especially of property with development potential, you might not quite know exactly what can be done with the property. Still, you don’t want it selling to someone else while you get town planning advice. An option can give you that time while protecting your ability to buy.
Market movement – locking in today’s price for tomorrow’s purchase has an obvious benefit if the market rises over the option period. Of course the reverse is true if the market contracts and you are forced to buy the property anyway with the “put” option.
Nomination – if your goal is to prepare the property for development approval during the option period and take the profits by immediate on-selling, you may be able to do so efficiently by nominating a buyer (with whom you have done a third party deal) when exercising your option.

Many of the elements of the option agreements have potential tax consequences so it’s good to work through those with your tax lawyer and accountant before committing.

Some Tips for Property Buyers Using Put and Call Option Agreements

While the concept of an option is fairly simple, sometimes the way they are prepared can make life a big headache.

Here are a few areas to ensure things are neat:

Ensure the option periods for each party are straightforward and easy to calculate. None of this “5 business days after the 3rd gibbous moon cycle” stuff is going to help you here. Be clear and make sure everyone is agreed about what happens when. Even common phrases like “business days” can cause a lot of grief, so it’s best to just have precise dates or precise numbers of real days – anything else is a problem waiting to happen.
Make sure the way the option/s are to be exercised is obvious and straightforward. Ensure the addresses for notices will still be around at the end of the option period (and don’t change your email address!).
Allow periods for both due diligence and development approval (if applicable) – we’ll work through this more in our example below.
As a buyer, you’ll need access to the property and potentially information for both due diligence and working towards the development approval. Make sure that these access and information needs are met.
As there is no real downside, give yourself a nomination clause so that you can nominate a third party to purchase whether or not that is your plan.
Take care to allocate risk for the property during the option period. Who is responsible for the risk of damage, flooding and the like? Are there insurance obligations?

A Practical Example of a Put and Call Option Agreement in Property

Joe wants to buy Suzie’s property from her, prepare it for development and on-sell it to a property developer.

They negotiate and both are happy to enter into a put and call option agreement for the property.

The agreement covers these essential terms:

Joe will pay Suzie $15,000 as the option fee immediately on signing.
The purchase price on exercise of the option is $1,000,000 plus any applicable GST.
Joe has 60 days to conduct due diligence on the property. If he is not satisfied for any reason with that due diligence inside 60 days he can terminate the agreement and receive back 50% of the option fee. Otherwise he is bound by the agreement going forward.
Joe has a further 120 days to obtain development approval.
During the first 180 days, Joe is given unfettered access to the site (empty land) and can conduct whatever testing or analysis on the property he desires, provided the property is not damaged in the process.
Suzie bears the risk and insurance obligations for the property until the sale contract. Suzie is not allowed to market the property or seek out other buyers during the option period.
Joe is permitted to nominate another buyer if he exercises his option.
If Joe does not exercise his call option by the end of 180 days from the option agreement, Suzie can exercise her put option within 14 days after that.
Any option exercise is to be by the relevant person signing the contract which is annexed to the agreement and delivering it to the other party’s lawyers’ office.

Of course while this simple worked example sets out the fundamentals, there are a lot more elements to consider when getting into more sophisticated property deals involving put and call option agreements. However – you can see how with a bit of consideration this can be a good way for Joe to make some money.

Here, Joe can prepare the land for development without having to purchase, seek out interested buyers along the way, potentially save on some tax and holding costs, and also get the benefit of any market increase over the next 6 months or so.

Don’t Do it Without Legal Input

This isn’t an area where you want to sign an agreement that hasn’t had a dedicated review from your property lawyers.

If you’re in the development space and wanting to explore a put and call option for your next purchase, give us a call and we’ll work it through with you.