Put and call options in a booming residential property market

The Sydney property market, especially the residential property market, is booming.  How long this will last, I have no idea, but I know it won’t last indefinitely.

I’ve noticed some increasing trends as a result.  One, that’s the topic of this article, is proposed option agreements.

Options agreements are agreements between a property owner and a buyer to enter a contract for the sale of land on a future date if one of the parties (sometimes either) to the agreement wish it.

An increasing trend I’ve seen many of my clients experience, is developers approaching residential landowners, where the land may be attractive for development, proposing to buy the land, sometimes for prices that seems quite flattering to the landowner, but often with certain conditions.

Usually, the residential landowner is inexperienced in these types of approaches and negotiations.

Developers often prefer options to buy land because it suits them.  They can use it to defer paying stamp duty on a speculative property purchase, or to avoid the purchase altogether.  As there is a delay, sometimes months, in a developer to prepare, lodge and eventually obtain development consent, if a property purchase isn’t delayed the developer sees the money spent acquiring the property so early in the process as dead money, or expensive money.  The developer is paying interest on loans and other property ownership expenses during this delay.

An option agreement allows the developer buyer to hold off buying the property until months later and, if it can’t get development consent, to avoid having to buy the property at all.

So, what is an option agreement?  There are usually two types:

Call Options

The party holding the call option is the potential buyer of the land.  A call option over land is the right of a buyer requiring a seller to sell their land to the buyer for a price at an agreed future date.

Put Options

A put option over land is the right of a seller to require a buyer to buy the seller’s land, again at the agreed price.

Sometimes both put and call options are combined in the one agreement, called a put and call option agreement.  Therefore, for example, if the buyer does not to exercise their call option, the seller can exercise the put option to force the buyer to buy the land.

Typically in option agreements:

• the buyer pays the seller a fee, often called an option fee, for the right to exercise the option by some future date, and preventing the seller from selling the property in the meantime to anyone else
• while there are no hard and fast rules, options fees are often equivalent to 1% of the agreed sale price of the land if the option were to proceed to a contract for the sale of land – I’ve see many agreements where the fee is much higher - if the option is exercised, normally the option fee is treated as being a part prepayment of the price
• the option fee is immediately released to the seller, non refundable to the buyer even if the option is not exercised
• parties must exercise their option rights within a time limit.

The examples above are not the only ways an option agreement operates, but it does give a sound general idea of how they work.

Seller Beware!

A landowner may consider there are benefits, including:

• the delay in selling may be suitable, knowing there’s a buyer committed to buy by a certain date
• the option fee immediately belongs to the seller, regardless if the sale occurs
• less stress in the selling process as there’s already a (somewhat) committed buyer and the price is known

Downsides to consider include:

• the seller is locked in!
• until the buyer exercises their option, if there’s no put option available to the seller, the seller can’t make plans, for example to move, to buy another property before the buyer is committed to complete the purchase
• the seller can’t agree to sell to a subsequent buyer who makes a more attractive and/or higher offer
• the market may change dramatically and suddenly – by far one of the worst possible outcomes.  If property prices were to fall, the buyer/developer may never exercise their option, so when the option period expires, the seller may have not only lost an opportunity to sell for a good price in a previously buoyant market, but the property’s value may have also significantly reduced

So, what to do?
My advice, particularly for a seller, is simply to ensure you really understand what option agreements are – they’re not all the same.

 

Know the advantages, disadvantages, as well as the possible consequences.  Realise it may not even suit your circumstances.

 

By far the best advice I can offer if you’re a seller approached by a buyer, a buyer’s agent, or a real estate agent, talking about options or delayed settlements, is don’t agree to anything, and certainly don’t sign anything, before you consult your own solicitor who will advise you and help you protect your interests.

Signing a contract outside of your solicitor's office? Be wary of last minute added clauses

In NSW, real estate agents are authorised by law to exchange contracts for the sale of residential property.  That authority is not unlimited however.

The law provides, paraphrased,  that a real estate agent may, presumably after a buyer has been found and a sale negotiated between the buyer and seller:

• complete parts only of a proposed contract (usually one that’s already been prepared by the seller’s solicitor or conveyancer) by inserting details of the buyer’s name and address, the name and address of the solicitor/conveyancer acting for the buyer, the price, and the date;
• insert in or delete from a contract description of any furnishings or chattels to included in the sale; and
• as stated, and providing they’re authorised by the seller or their solicitor/conveyancer “participate in the exchange or making of contracts”.

Despite these clear and limited provisions, it isn’t uncommon to find agents that regularly do more, sometimes much more, than this. 

It’s also not uncommon for contracts ending up in court litigating the meaning of clauses apparently quickly drafted and added very late to contracts; though well intended, ended up being difficult to understand or to make workable.

Regardless of their outcome, court cases are expensive and stressful.  If you find yourself in a situation negotiating the buying or selling of a property and clauses being drafted and added to a land sale contract by anyone other than through negotiations via the parties’ lawyers, think about what’s stated above.  You need to be aware of the risks.  If in doubt, it may be easier to just not sign, and to consult your lawyer.

Buying and “cooling off” – know this

Well first, why have this? It mostly results from attempts to reduce the practice of gazumping in real estate transactions.  More on this practice in a previous post. 

If you’re a buyer, there is information here that may be useful to you but always seek the advice of your own solicitor or conveyancer when looking at your own particular circumstances.

The law requires sellers of residential property to have a copy of the proposed contract available for inspection by any purchaser (link to relevant NSW law here).  The proposed contract here means the full proposed contract will all relevant documents, not a “draft” that’s still waiting for compulsory attachments yet to arrive.

Take a situation where, typically through a real estate agent, a buyer has negotiated a purchase of a house, the seller agrees to price and perhaps other terms.  The buyer hasn’t yet consulted their solicitor, they’ve heard something about pest and building inspections, and the bank loan still has to be organised.

Say you’re the buyer and you’re keen on the house – dare I say, you love it!   Understandably you’re also worried about signing a contract with these other things still to attend to.  Importantly, you’re also worried about losing the chance, especially because you’ve worked out that the sales agent, and other in his/her office are keen to sell to anyone else, even though you’ve done a deal while you’re off doing the other important things.

Where a buyer signs the contract with a real estate agent and the agent does the exchange of contracts, by law the buyer has a minimum 5 clear business days cooling off period – so weekends and public holidays are excluded.  If contracts are exchanged on a Tuesday afternoon, the cooling off period expires at 5.00pm on the following Tuesday; if the agent exchanged on a Sunday, the cooling off period expires at 5.00pm on the following Friday.

Now the buyer is meant to do what they have to do, for example consult their solicitor, arrange pest and building inspections, and ensure they obtain their unconditional loan approval for the funds they’ve applied to borrow.

The buyer is entitled to pull out of, or rescind, the contract for any reason whatsoever anytime during the cooling off period.  There is a relatively small cost; if the buyer exercises their right to withdraw from the contract, they forfeit 0.25% of the agreed sale price – typically this amount has already been paid to the agent at the time of signing.  The seller however, can’t rescind for any reason, even if they receive a better offer – see the same earlier post.

These days, many lenders are taking somewhat longer to approve loans.  If the 5 day cooling off period is too short and the buyer needs more time, before the cooling off period ends, the buyer can request and extension to the cooling off period.  To ensure problems are minimised, this is probably best done by the buyer well before the expiry time, and through your solicitor.

The cooling off gives buyers some peace of mind and a period of time to attend to and finalise matters relating to contract, secure in the knowledge sellers can’t change their mind or accept other offers, and goes some way in minimising gazumping.

Beware too.  Once the cooling off period comes and goes, unless the buyer has rescinded before the expiry time, the contract becomes binding and unconditional.

Are there any disadvantages?  Yes, there are some.  The first one is the cost of rescinding.  There are legal, inspections and other like fees the buyer incurs.  In addition, the buyer forfeits the 0.25% of the price to the seller.  On a $600,000 price, that’s $1,500 – it’s form of compensation to the seller.

Another disadvantage is that while terms of the contract can still be negotiated during the cooling off period between the parties’ solicitors, the bargaining advantage remains with the seller.  They know they have a keen buyer – the buyer has already committed a part deposit and incurred expenses. 

With this knowledge, sellers are generally less inclined to negotiate away terms compared to if the negotiations were taking place before contracts are exchanged and the seller wants to encourage a buyer to commit.  In my experience, I have found that there are now many more contracts drafted for sellers with numerous additional generic clauses to cover many contingencies in favour of the seller, sometimes even taking away or changing already very reasonable clauses in the “standard” contract.

Selling through a real estate agent? Talk to other agents first!

Most people who sell real estate do so using the services of a real estate agent.  For many of us, the buying and selling of real estate property is something that we do very few times; for that and other reasons, the process can be daunting.

This post is not another on “how to sell your house” or “… how to sell without an agent…” article; you find plenty of those elsewhere. 

I’m still consulted by seller clients who choose an agent at random and then don’t even consider speaking to more than one!

If you’re a seller, my advice simply is: speak to more than one agent!  At least two, preferably a few more.

Some years ago a client couple retained an agent to sell their home, agreeing to the agent’s commission of 6%!!  I asked why they hadn’t at least contacted another agent, if only to compare charges.  Their reply was that “…but he was so nice to us”!  At that time, other agents in that area were typically charging commission of around 2.5%.

More recently another seller client was quoted a commission charge of 4.1% plus GST!!  Unlike the other one, this client did talk to other agents and in the end, the first agent reduced his commission to 2.2% inclusive of GST.  The typical agents’ charge in this seller’s area is between 2 to 2.5% inclusive of GST.

Think about it.  On a $500,000 sale, the commission difference, coming straight out of the sellers’ pocket can be around $11,000 or more!

Obviously these are not common cases.  If you’re inexperienced or unsure, the best advice is that you first speak to your professional advisers.  As an absolute minimum, talk to more than just one agent, shop around, compare charges and sale methods, ask questions.  It’s only a small precaution when we’re talking of figures like $11,000.

First homebuyer? Stressed? Trust your solicitor.

In recent weeks I’ve noticed a spike in first home buyer related inquires, sales and purchases, which appeared to have some connection with the stamp duty exemption benefit ending soon that I’ve referred to recently.  

This article yesterday reports a surge in recent auction sales for the same reason, consistent with my office’s experience.

First home buyers range from the well prepared to the no so well prepared.  The common trait though is stress, anxiety and sometime anger – not uncommon emotions in the home buying experience.

No wonder, as a fair proportion of this results from the different advices, sometimes contradictory, buyers receive from numerous others, including from real estate agents, from families and friends, and from finance brokers.

My advice: trust your own solicitor, above all others, that have some connection with your transaction. Your solicitor is the one person that always offers unbiased help, guidance and advice.

If you’re feeling the pressure during your home purchase roller-coaster-like ride, your solicitor is the only professional that’s retained by you specifically to guide you, advise you, especially to protect you and your interests.  Remember that.

Sellers and Their Agents

Once a decision is made to sell real estate property, in my experience I find that almost all my seller clients have already consulted and signed up with their preferred real estate agent.

There are still occasions however where I'm asked by clients to review or explain their agency agreement before they sign up.

In these cases, over the years, apart from explaining the nature and effect of what are usually "exclusive" agency agreements, I've found that the advice I consistently emphasise includes asking my clients to consider:

• The exclusive agency period. It can be varied!
  
• The commission rate. Its usually negotiable.
• Make sure that the seller is a aware of ALL the potential costs
• Will the agent provide an "early release" guarantee?

More on these points below.

Exclusive agency period. In my view these should never exceed 90 days, but ideally ought to be no more than 60 days. I've been told by clients many times that when they've tried to reduce this period, the agent often protests that they need a decent time-frame to enable their marketing to work. Fair point, but I've also been advised by real estate agents that 60 days, even 30 days in some cases, is more than adequate to not only mount an effective campaign, but also to demonstrate to a seller the agent's genuine commitment.

Under an exclusive agency agreement, a seller is tied to their agent for at least that agency period. This means the seller can't really sack that agent in that time. Generally, that agent is entitled to commission if the property is sold during the agency period, regardless of whether the agent introduced the eventual buyer. If a seller is unhappy with that agent and attempts to "sack" that first agent and appoints another agent, the seller is under a serious risk of having to pay a full commission to two agents!

A shorter agency period gives a seller some flexibility. If they're unhappy with the agent's performance, at least it's a shorter wait to the end of the agency period after which another agent can be considered.

On the other hand, no matter what the length of the agency period, there's nothing stopping a seller entering a new agreement or agency period if they're happy with their agent's performance.

The commission rate - it's actually negotiable! I've commented on this previously. Speak to a number of agents before deciding who to engage. If anything, at least a seller can compare commission rates as well as other factors.

Check for other charges not so prominently disclosed. Make sure that the seller is a aware of ALL the potential costs. As well as commission, to determine whether it's inclusive of GST, and if other charges are additional, such as advertising costs. I've found most agency agreements don't include additional advertising costs but some do; it's something to factor in when making an informed decision.

Is an early release guarantee available? There are agents who subscribe to the Jenman system. One of its features is that no matter how long the agency agreement period, the seller has the right to cancel the agency agreement at any time.

A client of mine recently cancelled a 90 day agency agreement only days after making that agreement. Due to an inadvertent, and what would normally be considered a relatively very minor, error by one the agent's staff, the seller cancelled his agency agreement. The agent rectified the concern immediately, apologised of course, and asked the seller to take at least a day to reconsider. The next day, the seller confirmed his decision. To the agent's credit, the agent in this case honoured his guarantee and released the seller from the agreement, and lost an opportunity to earn quite a handsome commission. Ouch! That must've hurt! But full credit that agent - I'd suggest very few agents in that position would've agreed to such a release.

So, another consideration I'll now be consciously drawing to my clients' attention to if I'm asked to advise on agency agreements, is that they take into account whether a potential agent will provide a similar guarantee.

Sold! Now tell the tenant

Investors sell residential properties too. Obviously many such properties are tenanted when they're sold. It therefore amazes me how often I see sellers of such properties not being reminded, by their agent or lawyer, to notify their tenant to leave the property before the time the sale is completed in cases where the fixed term part of the tenancy has expired. This can result in any number of problems for both sellers and buyers.

The lesson at the end of this post is a simple one. If you've just sold a residential tenanted property in NSW where: (a) the tenancy has expired; and (b) the buyer is entitled to vacant possession; then make sure, and make sure again and again, that early and proper formal notice is given to the tenant to leave the property by just before the sale is completed.

In NSW, most private residential tenancy leases (or more correctly, Residential Tenancy Agreements) are governed by the Residential Tenancies Act. The Act sets out the minimum notice that must be given by a landlord to a tenant to end the tenancy and for the tenant to leave the property.

If the fixed term part of the lease has expired, generally the landlord must give the tenant a minimum of 60 days' notice for the tenant to leave the property. BUT, if the landlord has sold the property AND entered a sale contract, this notice period by the landlord is reduced to 30 days.

If a seller has not given the correct notice to a tenant, then that tenant is well within their legal rights to not leave the property. This can cause numerous problems.

For example, if the sale contract provides that at completion the buyer is entitled to vacant possession of the sold property, the seller won't be able to do so if the tenant is still in the property. This leaves the seller exposed to a breach of contract claim by the buyer.

Not that most buyers are ready to pounce to make a claim, however think of a situation where the buyer has already not only made moving arrangements, but given notice to their landlord, and that landlord has new tenants moving into that property, so the buyers can't just simply stay for just a little while longer.

The seller too, may have committed to another purchase that was also to be completed on the same day, but the sale proceeds from their frustrated sale are required to complete that purchase, which now too must be delayed. Now, the original seller could be exposed to another breach of contract claim, this time by the seller to them!

You can see now the beginnings of a domino effect happening. I had two situations within about the last 12 months where seller clients had what turned into unpleasant experiences but which thankfully did not deteriorate into what could've been much more costly incidents. In both cases, the agent was both the selling agent and managed the tenancy on behalf of the seller/landlord.

In the first case, once his sale contract became unconditional, following my advice the seller instructed his real estate agent to give the tenant notice of the end of the tenancy and to leave the property before the sale was completed. 31 days before the contract completion date, my client telephoned me to confirm he had given those instructions to his agent and the agent assured him that he would hand deliver the notice to the tenant that day; my client was satisfied with that.

Now, fast forward to the week before the sale was due for completion. The agent advises that the tenant refuses to leave the property as he had nowhere to move into. My client then finds out the agent simply forgot to give the Notice to tenant three weeks beforehand! In trying to make up for his forgetfulness and neglect, the agent frantically tries very hard to help the tenant find alternate accommodation. The end result is that completion of the sale occurs almost 3 weeks late. Apart from the stress, frantic telephone calls, disagreements with the agent, my client also pays almost 3 weeks' additional interest on the loan he was meant to discharge with the sale proceeds.

In the other case, the completion date was more critical for my vendor client. After obtaining reassurances, she made firm commitments to apply all the sale proceeds due to her on the sale completion date. She asked the agent to provide the formal written notice to her tenant, she called back afterwards and the agent confirmed he personally delivered the formal notice. My client then telephoned me to confirm all this. In addition, the buyers fixed the completion date to coincide with the completion of their sale. The buyers' representative had notified my client and I that my client's buyers had to move out of their house to let their purchasers in on the same date.

Well, you've probably guessed by now... About a week before completion the buyer's representative informed me that the agent informed them completion had to be delayed as the tenant was refusing to move out; their client buyer was frantic. It was the first I heard about this, and my client hadn't heard anything either. What also puzzled, and then angered, my client was why was the agent discussing this with the buyer and not with her? The agent refused to discuss the issue with my client, and even hung up on her! Remember, this is my client's agent!

The agent refused to provide to my client (his customer) and to me a copy of the Notice he earlier assured he had "personally delivered" to the tenant. It turned out that no Notice was ever given to the tenant by the agent. With the assistance of the buyers' representative, we managed to encourage the agent to finally come to the party. What appears to have happened is that the agent found, and paid for, for temporary accommodation and other compensation to the tenant, in return for the tenant agreeing to move out early.

In both cases the tenant was not given the proper Notice. This caused a lot of unnecessary stress upon sellers, buyers and the tenants. Any stress the agents may have suffered was self-inflicted. Additional unnecessary costs were incurred. In the circumstances, neither tenant was being unreasonable, they just weren't properly notified. So what lessons, or precautions, can sellers draw from examples such as the above two? I would suggest:

• where the fixed term part of the tenancy has expired, ensure that your agent (the agent managing the tenancy) gives adequate, and at least 30 clear days' written notice - preferably more - to the tenant to leave the property before the time the sale is completed;
• check with the agent regularly to confirm compliance;
• again, check and confirm with the agent;
• ask the agent to give you a copy of the formal written notice he provided to the tenant - if this request is refused or excuses are made, you should be hearing alarm bells!;
• if you're able to, and you're comfortable with this, consider personally giving the notice to the tenant yourself - if required, ask your agent or solicitor to draft a form of notice for you;
• keep diary notes of conversations concerning these.

I'm sure there's probably other precautions a seller could take, but this list should at least provide some guide for a good start.

Selling a property? Speak to more than one real estate agent

An alternative heading for this post could have also been "Sometimes a lawyer's best advice that a client should act on isn't even legal advice".

By far almost all sellers who decide to sell their real estate property, list the sale through a real estate agent. After all, it's an agent's business to market and sell property. Often sellers have chosen and signed up their listing agent before they consult their legal adviser.

Like many associations in life, prospective sellers sometimes have an existing relationship with a real estate agent, even before deciding to sell. It could be the agent through which the property was originally purchased, or the agent is managing the tenancy in the property, or a trusted friend recommended the agent.

No matter how well you think you know or trust an agent with whom you're just about to commit to, my advice is that always, always seek the opinion of at least one more real estate agent about the sale of your property, although another one or two more again wouldn't hurt. This is one piece of advice I've consistently given to sellers over many years.

After consulting one, you will be better prepared not only when consulting and asking questions to the next one, but also when, or if, you re-visit the first agent that was consulted. There are many issues to consider and negotiate, including commission rate, advertising, the possible selling price, and whether advertising costs are included.

Some time back a particular married couple consulted me about selling their home. I'd already known them, and knew they were both hard working, had a high level of debt, all on top of raising their young and growing family. They could ill afford to unnecessarily throw money away. Yet, that's exactly what they did.

They had already signed up with an agent, I can't now recall exactly when, but it was at least 3 or 4 days before consulting me, and the cooling-off time limit had already long passed.

It was while taking down other details, answering their questions, explaining the process when, as an afterthought, he handed to me a copy of the agency agreement they had both signed. It looked fairly typical, until I saw something that made me almost fall off my chair!!

The agent's commission was to be 6% of the sale price!!! 6%!!!

It got worse. On top of that, the agreement provided that the seller was also to pay the agent's advertising costs, some $700 to $800!

Think about it. If you sold your home today for, say, $500,000, at that rate the agent's commission on the sale would total $30,000, not to mention the GST and the advertising costs.

To put it into context, from my anecdotal observations, agents' quoted commissions on sales of typical residential properties, at least in the south-western area of Sydney, tend to fall between 2 to 3% of the sale price, usually roughly in the middle of that range. Some agents quote their fee as inclusive of GST, others don't.

Obviously I asked my clients a series of questions on how it came to be. They were a little perplexed at the fuss; they assured me that the agent had clearly explained to them his commission rate, he didn't hide it. They told me how the agent reassured them that that was HIS normal rate - I suspected it wasn't despite his very, very careful choice of words. "He was so nice to us. He explained everything..." they told me. He was so nice, apparently, that my clients didn't see the need to at least consider or speak to another agent.

If only they'd just spoken to another agent, even just a phone call. "If only..." At the very least they would've become aware that the 6% commission wasn't so normal after all. No holding punches here, this particular agent saw them coming, and he simply ripped them off!

The couple's house did sell, but unfortunately their story didn't get any better.

If you intend selling your property and listing it with a real estate agent - notwithstanding that by far most are reputable - the very least you should do is no matter how well you like or believe you have made up your mind, is speak and consult with no less than two agents before signing up with any agent. Sure, check out the agents' commission rates but remember, like many goods and services, price is just one of your many considerations.