Backed by Real Estate

Options are a great way to limit risk when entering into a market.  Stock options are similar to options in real estate, in that it is a way to minimize risk while maximizing your return on investment.

In simple terms, an option is a financial derivative that represents a contract sold by one party to another party.  The contract offers the buyer the right, but not the obligation, to buy a security or other financial asset at an agreed upon price during a certain period of time or on a specific date.

With stock options, there is a more detailed explanation for put and call options, each is its own strategy with a given stock during a given market for said stock.  For the purpose of this post we will not go into great detail of call and put option strategies.

A real estate option, in simple terms is the right to buy a property by the end of the option period.  If the property goes down in price by the end of the option period, the only investment at risk was the money put down for the option to purchase.  So if the deal goes south then you can walk away with losing a small amount versus owning the property and losing a substantial amount of an investment.

This is a similar type of risk minimizing strategy as with buying a stock option (whether a call or a put) and selling the option prior to its expiration versus buying and owning a stock.

The general strategy is to minimize risk while maximizing potential profit.

One difference with a stock option and a real estate option is the measure of volatility.  Real estate values do fluctuate a lot less than stock values during the same period of time.

A stock can be purchased at the opening bell, and then can have a change in value for better or worse by 20% or more within a few minutes.  Real estate values change at a slower pace, it is not likely for a home owner to go to sleep in a home worth $100,000 then find out by morning the price of the home has plummeted to $80,000.

Although a drastic change in value may happen in a quarter, it is not likely to change too significantly in one day; foreclosure areas are a good example of this.

As areas began experiencing a rise in foreclosures, the home prices began falling.  If a homeowner, not in distress, wanted to sell their property, the time to sell would be when the distressed neighbors are in pre-foreclosure, or when the area had little to no foreclosures.  Once the foreclosed property hits the market, the lender would first attempt to sell the property at market value, and then would begin entertaining reasonable lower offers on the property.

In the same scenario, if a person wanted to purchase a property and real estate market values were beginning to fall, instead of out right purchasing the property they could obtain a lease with the option to purchase the property, and in so doing they would limit the risk of owning a property that would be worth less than its purchase price.  If they purchase a property which is losing value the result could be less equity, no equity, or upside on their mortgage.

With a real estate option the potential buyer could just say no to the purchase, and walk away without having to lose anything more than the option payment.

With a real estate option it is much easier to enter and exit an opportunity than stock options, were you would have to sell your option to another buyer, and if there isn’t a buyer for when you need/ want to sell then you are stuck with your option.

Time is the enemy of options traders.

For real estate options time is a factor depending on your contract.  Some contracts ask for a 30 day notice for exercising or not exercising your option to purchase.

As a private lender for a property, the retail seller (borrower) would have to do all the “heavy lifting” of finding and evaluating the buyer/ leasee.

As a private lender you would still collect interest payments on a property as agreed, regardless of the retail seller (borrower) finding a person to buy, or lease with the option to purchase the property.

Tags: Business, business finance, Creative Real Estate Financing, Derivatives, foreclosure, Investing, Loan, Market value, Options, Options strategies, real estate