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September 2, 2014

The power of call options


Have you recently tried to secure a DA approved site in Sydney or even Brisbane for that matter? These sites are becoming scarcer as the markets heat up and quite often agents have a bidding war for such stock without the property even being on auction.

I don’t know about you, but I can’t always just suck a figure out of my thumb and know that’s the maximum I can pay for a parcel of land to allow the potential development to stack. As with all things, time is our enemy. Raw parcels of land are the way to go, but even raw land is taken up quickly by investors and developers or just locals looking to land bank. We need to think outside the box and potentially approach vendors who aren’t currently in the market to sell.

This is where I am a huge fan of call options. Investopedia defines a “call option” as: an agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period.

In real estate, this is a great way of securing a potential development site while doing your due diligence, and in some cases, even applying for a DA on the land you have secured. Call options allow you to do the following:

  1. Make an offer on the land with conditions.
  2. Specify a timeframe in which you wish to be able to action your call option and buy the land (usually long enough to ensure you can get the DA through).
  3. Submit a development application for the land at your own cost.
  4. Specify conditions in the call option that the vendor must be agreeable to sign relevant documents as part of a DA application.
  5. On-sell the option and/or the land during its currency period.

As with all offers, a deposit is required and usually the market would dictate 10 per cent of the future purchase price to be held in trust, but the figures are always negotiable.

Very often when you see a DA approved site for sale on one of the major listing websites, it’s someone exercising their right to on-sell their call option and most likely at a profit.

There are some pitfalls to look out for, which can include getting lost in the jargon.

Put options can be one of these examples, and even though it’s a commonly used tool in land development, for what we’re trying to achieve as profitable small developers, we should try to avoid them.

Investopedia defines “put options” as: an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares.

Though not specifically focused on real estate, the gist of the above is that the vendor can force you to purchase the property at a specified date if you haven’t been able to on-sell the stock within the specified timeframe as part of your call option. Put and call option combinations are very common with new land developments and infill estates where there’s a lot of competition between builders, marketers and speculative developers trying to secure the land stock.

I suggest you do some research on council planning and find the correct density areas for what you’re trying to develop – whether it’s a small block of units or townhouses. Once you’ve established the areas, find a few properties you think might be suitable and try to get in touch with the vendor. Once you’ve made contact and gauged their interest, get in touch with your solicitor to draft a personalised call option document and present your offer formally to the vendor and take it from there.

Bear in mind, very rarely does this actually lead to successfully securing a site and it might take one out of every 50 attempts before finding a vendor who is willing to play ball. However, it’s a great way of doing research and ultimately a lower risk way of securing a development site – which you then get to mould into your vision of the ideal development for that particular parcel.

About Sam Saggers

Sam Saggers is the CEO and co-founder of Positive Real Estate, an author and a regular contributor to the Australian national media. Sam is a passionate educator, a sought-after spokesperson and offers his wealth of experience to educate investors on the complexities of real estate investing.

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