When buying or selling residential property, sometimes you also need to buy more time.

If you're a buyer looking to redevelop a property, you may need time to conduct due diligence or obtain development approval. You don't want to lock yourself in, but you also don't want to let other buyers swoop in and snaffle the property while you're still making inquiries.

If you're a seller, and expect to make a large capital gain on the sale, you may wish to lock in a buyer now but defer your capital gain to a future date.

In these situations, you might consider using an option agreement to protect your position.

What is an option?

Options come in two forms.

A call option gives a potential buyer (called the "grantee") the right to compel a property owner (called the "grantor") to sell the property to the grantee at an agreed price. In the meantime, the grantor must not sell the property to any other person.

A put option is the inverse of a call option; - it gives the property owner the right to compel another person to buy the property at an agreed price.

Options are created by written agreements. Commonly, only a call option will be granted. Sometimes, a put option will also be created by the same agreement, so that either party can compel the other to complete the sale and purchase of the property.

Typically, the grantee of a call option will pay the grantor a non-refundable "option fee" at the time that the call option is granted. The option fee might be, say, 5% of the agreed price. If a put option is also being granted, the property owner will typically pay a nominal option fee, such as $1.

The agreement will specify an "option period" which is the period of time during which the party with the option in its favour may exercise their option. The agreement will also set out the procedure which that party must follow in order to exercise the option.

When and if the option is exercised, a binding contract for the sale and purchase of the property is deemed to have been entered into. Nevertheless, the parties usually exchange formal contracts for the sale and purchase of land at the agreed price, as they would with an ordinary conveyance.

If the option is not exercised during the option period, the option lapses and the parties are freed from their obligations.

Beware of traps!

In New South Wales, strict requirements apply to option agreements in relation to the purchase of residential property. Failure to take heed of these requirements can cause an option agreement to be void or able to be rescinded by the other party. For example:

  1. the option agreement must include, as an annexure, the full contract for the sale and purchase of land including all the documents prescribed by the Conveyancing (Sale of Land) Regulation 2017 (NSW), such as a planning certificate, sewer diagram and swimming pool certificate of compliance;
  2. a call option must not be exercisable within 42 days of the date it was granted;
  3. the parties must execute and exchange separate duplicate option agreements. It is not sufficient for both parties to sign the one document;
  4. if an option agreement creates both a put and a call option, both options must be given for consideration. It would be prudent for the parties to hand over cheques in respect of each option fee, even if the fee is only a nominal amount, to evidence the giving of consideration; and
  5. unless the grantee's solicitor gives the grantor a certificate under section 66ZF of the Conveyancing Act 1919 (NSW), or the call option was granted on the same day that the property was passed in at auction, the grantee of a call option will have a cooling-off period of 5 business days.

In addition, the option agreement must be drafted carefully to avoid unintended tax consequences. Depending on how it is drafted, for the purchaser, no stamp duty is payable on the option agreement, but duty is payable on the contract. For the vendor, capital gains tax on the purchase price is not triggered until contracts for the sale and purchase of land are exchanged, although there may be capital gains tax payable on the initial option fee. Hence, if drafted correctly, options can be an advantageous way to commit to a property transaction without incurring immediate tax liabilities.

If you're looking to buy and develop residential property, or to sell your property to a developer, an option agreement may suit your circumstances. You should engage a solicitor to correctly draw up the option agreement and guide you through the process of creating and exercising the option.