Leverage is the use of borrowed money to control something of value. Real estate investments for many years have afforded the investor some extreme leverage situations. Let’s examine leverage. If double-digit inflation returns, controlling the maximum amount of real estate may be extremely desirable. One way to do that is with an option.
High leverage is an excellent benefit. Remember though, that with an option there is a problem. Options have an expiration date. If you haven’t gotten the desired increase in value by the time the option expires, you must make the choice – buy the property and wait longer, or let the option expire.
An option is simply a contract that gives the purchaser a right to buy a certain property at a certain price for a certain period of time. Sometimes a seller will sell an option to purchase his property because the amount of money paid will solve an immediate problem, and it really does make him feel that the property is sold, or will be sold.
Always ask yourself a few questions before buying an option:
• Will you have enough money to exercise the option at the expiration date if no loans are available?
• Do you think the property will increase substantially in value during the option period?
• Will the profit be large enough to chance the loss of a small investment in the option on the property?
Suppose you buy an option to purchase a property during a period of the next three years. You have set the option price at today’s market value and put up only about 10% of the ultimate purchase price. You wait three years and find that you guessed right! The property has increased in value by $100,000. You can now make some choices on the next move:
• Exercise the option. You can buy the property. Maybe you can borrow the amount of the purchase price on the land and buy for no money down. To sell at a long term gain, you must now hold it for six months, or longer.
• Sell the option. You might sell the option for the $100,000 cash to someone who wants the land. This would be an immediate long term gain since the option has been owned for more than the minimum time period.
• Settle the option. The profit is yours because the present value is higher. What if the original owner who sold the option to you now sees more future value in the property and would like to continue owning it. The original owner might buy the option from you or settle it with you in some other way. Perhaps a joint ownership could be arranged, with both of you taking a further holding position for more profits in the future.
The Risk
Remember, the market tends to reward those who take risks. When you minimize risk too much, play it too safe, you may give up the chance for larger profits.
See Us For Investments
Serious real estate investors may want to own real estate for cash flow, tax shelter and reasonable growth. Maybe you would also like to invest something for a long term growth, such as land speculation. Come in and see us. Perhaps we can help you with choices and do some of the research for you.