There will be occasions where property investors have been overstretched in the short term and may be lacking in liquidity. This always seems to be the time when the “best investments” appear. Thankfully, there are fairly standard land purchase option contracts available today which offer the opportunity to acquire an option (but not always the obligation) to acquire land at a set price over a set period.
Why would you take out a land purchase option?
As we touched on above, the most common reason is short-term cash flow. If you pay down a non-returnable deposit for the option to acquire the property at an agreed price over for example a 12 month or two year period, this allows you to keep your options open and perhaps raise additional finance. There are also other situations where investors may see the opportunity to flip the property for a profit or else apply for planning permission and see an immediate increase in the perceived value.
Are these contracts watertight?
It is really up to the seller and the potential buyer as to how watertight these contracts are and whether each party has the option to walk away with or without any compensation payment. The standard practice would be to agree a legally binding security arrangement over the land. In effect this would stop the owner from selling the property, without the potential buyers consent, over the period of the option.
For reference, the payment of a non-refundable deposit is often a precursor to an agreement which offers the potential buyer the option but not the obligation to acquire the land at the agreed price. In effect, the potential buyer has the opportunity to walk away with the initial deposit seen as a form of compensation for the seller.
Balancing the risk/reward ratio
Obviously, if you were to invest in an array of property purchase options with the opportunity, but not the obligation, to acquire land, you would have to make at least one of the options work. Non-refundable deposits can very quickly add up therefore it is sensible to go in with the intention of taking up the option after doing extensive research. There is obviously money to be made in pure speculation but if for example you were looking to acquire land worth £200,000 and forced to put down a 10% deposit, this would be £20,000. If you try this approach over two or three different areas of land then you are talking up to £60,000 in deposits which would normally be non-refundable.
Many people will acquire these options with the intention of reselling the property (or option), or putting in place a resale agreement, prior to taking up the option and paying up in full. So, if for example you were acquiring land valued at £200,000 and you put down a £20,000 deposit, you would have an additional £180,000 to pay. However, if in the meantime you were able to sell the land on for £250,000 then in theory you could use £180,000 from the sale proceeds to complete the purchase thereby locking in a profit of £50,000, i.e. a 40% return on the initial £20,000 outlay.
Short-term finance
There may be a requirement for development finance to cover the period between taking up the option, completing the purchase paperwork on the land and completing the sale. However, assuming that the sale contract was water tight, funds were paid into an escrow account, there would be no issue with raising this type of finance. In effect it may only be required for a number of days to crystallise a £50,000 profit on an initial outlay of £20,000.