Option Pricing

[tmccoy8585]

I have found a parcel of raw land that I might be interested in developing. Not a huge project, but it would be my first try at development so I want to proceed cautiously.  If, after doing some preliminary due diligence (zoning considerations, utility issues), I determine that I want to proceed, I think I would like to proceed by acquiring an option on the property (seller willing).  I would then be free to shop for prospective tenants, construction financing, and builders.  Is this the correct route to go?  If it is what would be an appropriate price for an option? What would be an appropriate length for the option to last?  The property is listed for under $300,000.00 and its been on the market for 2 years.            

[mark2616]

Option pricing is terribly complex.

If the parcel is fairly priced in its current condition (i.e. no zoning change contingencies, no enviornmental remediation, etc.) then the option fee should be about 10% of the price per year. This compensates the owner for passing up the opportunity to sell and take his cash now.

The option fee goes down for each "ding" on the project. For example:

If the property is over-priced then the option fee becomes sort-of a crap-shoot as to whether the property will reach that value during the option period-- therefore  the odds of the option not being exercised goes up and the amount of money you are willing to throw at it should go down. In addition the opportunity costs to the seller are lower since he probably wasn't going to sell at that price anyway.

Over-priced includes over-priced for its current situation. I see deals all the time where some piece of dirt would be worth double if the zoning were changed. Only problem is its already priced as if the zoning were done. Lets say there's a lot worth $100k but it would be worth $200k if the zoning were C instead of R. Seller is asking $150k. an option at $150k with the right to petition for the zoning change would be worth smaller dollars, say $1,000 or 1% of the "value" because the option price is already inflated.

2 years on the market is a pretty good indication that the property is over priced and your option fee should be small.