Understanding Call Options in securing a property
In the general sense of the term, a call option is described as financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price. This is according to Investopedia.
At The High Option, we often use call option agreements to create a pool of buyers who have committed themselves to buying a property within a development, once the development is completed and ready for transfer.
It works this way…
For a small amount, say R5 000 to R10 000, you secure a call option to buy a predetermined property in a development for a predetermined price. When the time comes to call the option, the deposit is paid and the bond application is made through a mortgage originator. If your bond is not approved, your transaction will be terminated without risk to you and your option fee and deposit is refunded in full.
This is a risk free opportunity to invest in a future property at a predetermined value. However, if the transfer is delayed to such an extent that the purchase price has to be increased, you have the option to resile or accept the increased price.
Call Options differs from “delayed transfers” in one respect; the upfront amount you have to put down.
With a delayed transfer, you have to put down between 10 and 15% of the purchase price as a deposit. If you therefore buy a property in a new development for R1 million, you have to put down R100 000 into an interest bearing trust account held by the transferring attorneys. The interest on these accounts are generally linked to the prime lending rate plus a few % points, which is often set-off against bank charges and fees. Leaving you with no or very little “interest” at the transfer date.
With a call option, the same process would apply, except that you still have, like in the case above, R90 000 which you do not have to put into a low-earning trust account.
Only once the call is made, and the option exercised, do you have to put down the deposit of 10% on the purchase price.
Call Option fees are paid into the trust account of the Appointed Property Practitioner, dealing with the development in question, while Deposits in respect of the ensuing deed of sale, are paid to the appointed Transferring Attorneys.
Another variant of the Call Option, is the Put and Call option agreement, and this is more commonly used in near-transfer developments. The Call option remains the same, but an added option; the Put Option, affords the developer the right to exercise the option from their side. Where the option holder has the right to Call for the property to be sold, the developer has the right to Put the property on the table to buy it.
In a Put and Call agreement, neither the developer or the buyer can simply pull out of the deal, except where the suspensive conditions cannot be met within a specified time. The specified time is the time when the developer has to offer you the property, and you have to take it. It is normally between 6 and 12 months from the date of the Option agreement. It is unlikely that a Call Option will be issued over a longer time, as the risk of selling prices increasing is much greater.
For more information on properties available using the Put and Call Option Agreement, get in touch with us via telephone.
Some common questions people often ask
Why should I buy a Call Option?
If you know that a property of the same extent and area sells in excess of R1 million, and the Call Option gives you the opportunity to buy it 12 months from now, at less than current market value, the Call Option makes good investment sense, particularly if you want to speculate with real estate. In short, it gives you a window of 12 months to sell the property for more than you can buy it. Once you have the Option agreement, you can sell the property for R1,2million to be available in 12 months. By the time the option is called, you take transfer at the same time your buyer will take transfer, giving you an instant R200 000 profit for an investment of R10 000 (As the option fee). Please note that the “flipping” of real estate may incur Capital Gains Tax.
Why would a developer sell a Put Option?
We cannot speak for others, but in managing our share holder risk, we need to have a “take-up indicator” to ensure the development is well worth the investment. Using the Call Option on its own, has no real risk mitigation built in, as the option does not have to be exercised if the buyer change his or her mind. Once the Call Option has expired, the property is released for resale, and an over supply of released properties in a development, would negatively influence the selling price. As the call option only secures your right to buy, but not the obligation to buy, the Call Option is accompanied by the Put Option. In terms of the agreement, but the developer and buyer agrees to act when the option is exercised by either party.
Can you call an option before the closing date?
No, as the suspensive condition has not yet been met and the right to call is not in effect yet.
When does the Call Option expire?
It normally expires 30 days after the suspensive conditions have been met.
What happens if I don’t call the option?
If you do not exercise your option within the allowed 30 days, it will expire and the option fee is retained by the developer as compensation for loss of a deed of sale. However, the developer also has same right (the put option) and chances are slim that it won’t exercise this right. In most cases, both parties have a mutual interest in the transaction and it is yet to happen that neither fail to exercise their rights.
Is there any circumstance under which I can lose money?
No; not if you deal with a reputable developer who has a reputable team to manage the transactions. In our case, we do not handle any funds during the prelude to the transfer. The only time we receive or will ask to receive moneys is when the development is completed and the property is ready for transfer into the new owner’s name.