Understanding Option Agreements
How option agreements work, why developers use them, and the commercial terms owners should understand before agreeing to a long-dated transaction.
A detailed guide to call options, put and call options, the contract of sale, who drafts each document and the commercial terms that materially affect owner risk.
What an option agreement actually does
An option agreement, sometimes called an option deed, is one of the most common structures developers use to secure a development site. Rather than buying the property outright on exchange, the developer pays for the right to buy it within an agreed timeframe, at a price that is fixed today.
The owner who grants that right is called the grantor. The developer who receives it is called the grantee. These terms appear throughout the option deed, so it helps to know which side of the transaction each one refers to before reading the rest of the document.
Why developers use option structures
Development sites carry substantial upfront risk before a single brick is laid. A developer is rarely in a position to pay top dollar and settle within a standard 42 or 90 day contract, because the price they can justify depends on planning outcomes, feasibility and funding that are not confirmed yet. An option gives them time to de-risk the project while the owner's price is already locked in.
The option period allows a developer to:
- Lock in today's purchase price
- Defer stamp duty on the acquisition
- Coordinate architects, planners and other consultants
- Negotiate with neighbouring owners to amalgamate the site
- Lodge for and secure development approval
- Secure debt and equity funding
- Get the project construction ready
- Meet any pre-sale hurdles their financier requires before the project can begin
The stamp duty deferral is one of the main reasons developers structure acquisitions through options. On larger development sites, the duty payable runs into hundreds of thousands, and often millions of dollars, so pushing that cash outflow to the back end of the transaction (rather than paying it on day one) is a material cash flow advantage.
Call options and put and call options
A standard call option gives the developer, the grantee, the right, but not the obligation, to complete the purchase. If the developer does not exercise that right within the agreed option period, the owner keeps the property and retains the option fees paid for the exclusivity, with no obligation to sell.
Call options are typically used where the developer is taking on extra planning, market or amalgamation risk that has to be worked through before they can fully commit. Common examples are pre-rezoning sites, sites whose value depends on approvals still being worked through with council or the State, or staged amalgamations that depend on other neighbouring owners aligning. In those situations, a call option is often the structure that makes the deal possible at all, because the developer needs a route to walk away if the underlying assumptions do not eventuate.
The owner is compensated for that flexibility through a materially stronger headline price than a short unconditional contract would attract.
A put and call option builds a second right on top. Under a put and call structure, the developer's call option is exercisable first, within the timeframe set out in the deed. If the developer does not exercise it, the owner then gains a put option, exercisable within a further agreed window, which compels the developer to complete the purchase. If neither option is exercised, the agreement simply expires.
Each site and each transaction carries a different risk profile, and owners have different appetites for that risk. The right structure is the one calibrated to the specific site, the state of planning, the developer's position and the owner's appetite for trading certainty of completion for a stronger commercial outcome.
Option fees and the security deposit
Because the owner's property is effectively taken off the market for the length of the option, often many months or longer, the security deposit compensates them for that exclusivity. It is typically structured as a percentage of the purchase price, commonly in the order of 1 to 5%, and released in tranches across the option period rather than paid as a single lump sum. If either the call or put option is exercised, the option fees are generally credited towards the deposit payable under the contract of sale, subject to the terms of the agreement.
The contract of sale is fixed before you sign
This is the detail owners most often miss. A complete contract of sale, covering the price, deposit, settlement date, special conditions, easements and any other terms of the eventual sale, must be annexed to the option deed itself. That contract is not drafted later once the developer decides to proceed. It is negotiated and agreed upfront, before the option period even begins, and it is that exact contract which becomes binding the moment either party exercises their option.
In practice, this means owners are negotiating the full terms of their eventual sale at the very start of the process, not months or years later when the developer is ready to settle.
Who drafts the option deed and the contract of sale
Drafting responsibility is split between the two solicitors, consistent with standard NSW conveyancing practice. The developer's solicitor prepares the first draft of the option deed, because the developer is the one requiring the specific conditions, timeframes, due diligence rights and nomination clauses the structure is built around. That draft is provided to the owner's solicitor for review and negotiation before either party signs.
The contract of sale annexed to the option deed is prepared the other way around. Under standard NSW practice, it is the vendor who is required to issue the contract of sale, including the statutory disclosure documents required under the Conveyancing Act 1919 (NSW), such as the title search and planning certificate. The owner's solicitor drafts the contract of sale and provides it to the developer's solicitor for review. Owners should generally use a solicitor experienced in development transactions, not a general conveyancer.
If you have been offered an option agreement, or a developer has raised one as a possible structure, get in touch for a site assessment to know if what is being offered is consistent with the market or if it can be improved.
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