Financing and partnerships
The Option Contract: Buy Multifamily With $0 Out of Pocket
Two ways to use an option contract: buy your partners out at a fixed price years later, and control an underperforming building you can't finance today.
The option contract is one of the most powerful tools you have in creative finance. It's what has allowed me to buy deals with actually $0 down and end up owning them without any partners.
Related reading: Creative Equity: How to Fund Any Deal Without Money or Credit
There are two main ways we use option contracts, and I'm going to go through both. If you're starting with zero dollars like I did, you can buy hundreds and hundreds of rentals by correctly using an option contract in your deals. Honestly, I don't know why more channels don't talk about this.
What an Option Contract Actually Is
Anytime we buy a piece of multifamily real estate and there's a partnership involved, we have to hold it in an LLC that represents the interest of that partnership. When you draft the operating agreement for that LLC, you lay out who put in what capital contribution, how much money went in, and how much equity everyone owns.
On the back end of that agreement, you attach an option contract.
An option contract is an option to purchase an individual's equity in a property at a fixed price, in a fixed period of time. That's it. Fixed price. Fixed window.
This works whether the deal is conventional or seller financed. If you need to bring a down payment into a deal, or you're working with a bank and you need a partner to either bring that down payment or simply help you qualify for the debt, you can use this in every single deal you do.
Use One: Let the Real Estate Buy Out Your Partner
Here's the example.
I'm 50/50 partners with someone named Ryan. Ryan puts in 100% of the down payment on a million-dollar property: call it $100,000. That's his capital contribution. In this deal, I found the deal, I put the deal together, and I'm going to be the primary day-to-day operator.
Our option contract says that Ryan's equity, even though he only put in $100,000, can be bought out by me in, let's say, five years for $200,000.
In that scenario, Ryan doubles his money. I own 100% of the real estate. And critically, it gives me five years to find the $200,000.
Where does that money usually come from? As we operate the deal over five years, rents go up. We get better at operating. We make improvements to the property. Then we do a cash-out refinance. Even if the deal was seller financed at 10% down, we go get conventional financing, pull money out of the deal, and pay Ryan his $200,000.
The real estate bought the real estate.
If you're tracking the math: how much money left my bank account during that transaction? Zero dollars. And zero is correct.
The option contract is very similar to treating the other person's equity like debt: except that it's optional. I have the option to buy them out at a fixed price in the future.
The Rule You Can't Break: It Has to Stay Optional
One important legal point. Option contracts are, by definition, optional. You cannot make the buyout required.
If you make it mandatory, that's debt, or you're creating a security, which you do not want to do. Securities are a different legal structure and you have to file them with the SEC. We're keeping this simple and staying out of that.
So how do you give your partner confidence that the buyout is really coming if it's genuinely optional? You create penalties for not exercising it.
Go back to the deal. It's a $1 million, 10-unit building. It's beautiful, it has value add, and we believe we can increase the value enough to pull out the money and double Ryan's money while I put $0 in. But Ryan and I don't want to be partnered together forever. We want a clean break. He'd like to be bought out for that $200,000 by no later than year five.
So we write in a penalty: he provided all the money, I found the opportunity, and in the event that I do not buy him out, he gets 100% of my equity.
Think about what that does. Ryan carried all the financial risk on this deal. If we couldn't double his money and buy him out, my equity is forfeit to him. It's not mandatory. It's not a requirement. It's still an option: my option is either I give my equity to Ryan at the end of this project, or I give him $200,000 and I get to keep the deal.
That structure let me buy a deal with no money.
And there's a second benefit. If that deal was bank financed and I didn't qualify for the debt myself, Ryan's qualifications counted toward the loan. In five years I still have to qualify for the new debt, but I have five years to work on whatever I need. Net worth, credit score, whatever it is. Five years to position myself to qualify, take the debt out, buy the property, and let the real estate buy the real estate.
What Happens If You Skip It
If you don't attach an option contract, and you don't have a fixed price to buy your partners out, you can still buy them out, but it becomes a total negotiation in the future.
You don't know how expensive it will be. You don't know if they'll even agree to it.
It's a best practice to put these in place at the beginning of your deal, when everyone is happy, everyone agrees on the numbers, and nobody has emotion tied up in a building that's now worth more than anyone expected.
And if the partnership turns out to be fantastic? Remember, the option contract is optional, and anything you put in writing can be renegotiated as long as all parties agree. If you get to year four and decide you love the partnership (in fact, you want to go buy more buildings together in a similar structure) you can amend the operating agreement, cancel out the option agreement and its associated penalties, and move forward with a new partnership.
That's the beautiful thing. It gives you options, and it gives you a path to own your portfolio without any partners. Fixed timelines, fixed prices, set terms.
Add this to every single partnership you have. Don't design your partnerships to be a marriage. You don't want to be partnered with everyone forever. You want the ability to control your real estate. You found the deal, you lined up the capital, you got them their return: keep the real estate.
Use Two: The Management Option Contract
This second use is really interesting.
Our rule is that we buy deals that cash flow day one, no matter what. We buy a deal, our income goes up. Period. Full stop.
But what if there's an underperforming property and the owner won't let you get creative with the financing to the point where you can get the deal to cash flow? What I mean is: there's no deal structure available that gives you the cash flow you need and gives the seller everything they want. They want too high a price. They're only okay getting cashed out: so they need bank financing or a check for the entire amount.
You can solve that with what's called a management option contract. It's very similar to a lease option, except in this case I take over management of the entire building, along with an option to purchase at a fixed price in a fixed period of time.
So if a property is underperforming and the owner is having difficulty getting it into a position where it would be bank financeable, you take control of the property through the management agreement. You'll typically pay an option fee, which (like the first example) can come out of your own money or out of raised capital. You bring the option fee, you take control of the building.
Then you write a business plan for them: this is how I intend to get this property into a position where we can get bank financing and get you your price.
If the price is a good price in the future, once the property is performing better, this gives you a solid chance to execute your business plan and close on the seller's terms.
One caution. You typically want to negotiate for seller financing or another creative route first. This option is only to be used if there's no other way to do it. Ultimately what you want is that the day you come to an agreement, you go under contract and you own the property.
But if there's no way to do that and you love the deal and you believe in your business plan, this lets you put a pin in the map. You know when you're acquiring the property. You know what you have to do to make the property worth equal to or greater than the price they want. It gives you control of the building now, and the option contract buys the real estate later: again, with no money to low money down.
Key Takeaways
- An option contract is the right to buy a partner's equity at a fixed price within a fixed window. Attach it as an addendum to the LLC operating agreement.
- The classic structure: partner brings the down payment, you bring the deal and the operations, and you buy their equity out later at a multiple. In the example, $100,000 in and $200,000 out at year five.
- The cash-out refinance is what funds the buyout, so the real estate buys the real estate and nothing leaves your bank account.
- It must stay genuinely optional: never mandatory, or you've created debt or a security. Use a penalty clause instead, like forfeiting your equity to the partner if you don't exercise.
- A partner's qualifications can carry the bank debt today while you spend the option period building net worth and credit to qualify on your own.
- The management option contract is the fallback when a seller won't get creative: pay an option fee, take over management, present a business plan, and buy at a fixed price once you've made the property worth it.
This is how you buy massive amounts of real estate when you have literally no money, or just less money than the amount of real estate you want to buy. It's also how I've bought so much of my own portfolio and how I'm the sole owner of it today.
Watch the full video for the Ryan example walked through step by step. If you want the fundamentals first, there's a free multifamily training course in the description, the Facebook group is open, and the mentorship page explains how we work through structures like this on real deals.
Read the episode transcript
0:00 The option contract is one of the most 0:01 powerful tools that you have in creative 0:03 finance. This has allowed me to buy 0:05 deals actually $0 down and own them 0:07 without any partners. There's two main 0:10 uses in creative finance that we use 0:12 option contracts. I'm going to go over 0:13 both in this video, but seriously, if 0:15 you are starting with zero dollars like 0:16 I did, you can buy hundreds and hundreds 0:18 of rentals by correctly using an option 0:20 contract in your deals. Here we go. So, 0:23 first of all, the most common and my 0:24 favorite way to do it, conventional or 0:27 seller financed, if you need to bring a 0:29 down payment into a deal, or if you're 0:30 working with a bank and you need another 0:32 partner to either bring the down payment 0:34 or even just qualify for the bank debt, 0:36 you can use this trick with the option 0:38 contract in every single deal that you 0:41 do. Here's how it works. When you draft 0:44 your operating agreement for your LLC, 0:46 which anytime we buy a piece of real 0:48 estate that's multif family and there's 0:49 a partnership, we're going to have to 0:51 have it in an LLC that represents the 0:52 interest of the partnership. We're going 0:54 to lay out in that who put in what 0:56 capital contribution, how much money, 0:59 how much equity everyone owns, and on 1:01 the back end, we're going to attach an 1:03 option contract. Now, what is an option 1:06 contract? This is an option to purchase 1:08 the individual's equity in a property at 1:10 a fixed price in a fixed period of time. 1:13 For example, I'm 50/50 partners with 1:16 someone named Ryan. Ryan puts 100% of 1:19 our down payment for a million-doll 1:20 property. Let's call it $100,000. That 1:23 is his capital contribution. Now, in 1:26 this deal, I found the deal. I put 1:28 together the deal, and I'm going to be 1:30 the primary day-to-day operator of the 1:31 deal. Our option contract says that 1:34 Ryan's equity, even though he put in 1:36 $100,000, I have the option to buy him 1:39 out in, let's say, five years at 1:42 $200,000. In this scenario, Ryan would 1:45 double his money. I would own 100% of 1:48 the real estate, and it gives me time to 1:50 find the $200,000. Now, where does that 1:52 money usually come from? Well, as we 1:54 operate the deal and five years passes, 1:56 rents go up. We get better at operating. 1:58 We make improvements to the property. 2:00 Typically what happens is that's when we 2:02 do a cash out refinance. Even if it was 2:04 seller finance 10% down, we're going to 2:06 go ahead and get conventional financing. 2:08 We're going to pull money out of the 2:09 deal. Pay Ryan his 200,000. The real 2:13 estate bought the real estate. Now, if 2:14 you're tracking the math here, how much 2:15 money left my bank account during this 2:17 transaction. If you're tracking with me, 2:20 $0. And $0 is correct. Option contract 2:23 allows the real estate to buy the real 2:24 estate. It's very similar to treating 2:27 the other person's equity like debt 2:29 except that it's optional. I have the 2:31 option to buy them out at a fixed price 2:32 in the future. Now, if they're expecting 2:34 the buyout and that's part of the 2:36 expected compensation. One thing with an 2:37 option contract, they are in fact 2:39 optional as per the definition. You 2:41 cannot make it required. That's debt or 2:44 you're creating a security which you do 2:46 not want to do. There's different legal 2:47 and you have to file those with the SEC. 2:49 For this video, we're going to try to 2:51 avoid that and keep it very very simple. 2:53 So, you can create penalties if you 2:55 don't buy them out. For example, I find 2:58 this deal. It's a million dollars. It's 2:59 a 10-unit building. It's beautiful and 3:01 it has some value ad where we do think 3:03 we can increase the value enough to pull 3:05 out the money to double Ryan's money 3:07 with us putting $0 into our deal. 3:09 However, Ryan and us don't want to be 3:12 partnered together forever. We want to 3:14 have that clean break. He would like to 3:16 be bought out for that $200,000 by no 3:18 later than year five. We can put a 3:20 penalty in there that says, "Well, you 3:22 provided all the money and I found the 3:23 opportunity. And in the event that I do 3:26 not buy you out, you get 100% of my 3:28 equity, which means Ryan had all the 3:30 financial risk in this deal. And if we 3:32 were unable to double his money and buy 3:34 him out, my equity is now forfeit to 3:36 him. It's not mandatory. It's not a 3:38 requirement. Still an option, but my 3:40 option is either I give my equity to 3:42 Ryan at the end of this project or I 3:44 give him $200,000 and I get to keep the 3:46 deal." This structure allowed me to buy 3:47 a deal with no money. And by the way, if 3:49 this was bank financed and I didn't 3:50 qualify for that bank debt, Ryan's 3:52 qualifications was also count towards 3:54 that loan. Now, in five years, I still 3:57 have to qualify for the new debt. But it 3:59 gives me five years to work on whatever 4:01 I need, be it the net worth, be it the 4:03 credit score, whatever it is, it gives 4:04 me five years to position myself to be 4:06 in a position to qualify for the debt, 4:08 take it out, buy the property, and the 4:10 real estate will buy the real estate. 4:11 The option contract as an addendum to 4:14 your operating agreement when you create 4:16 the LLC. This is the way that you buy so 4:18 much real estate and how I've bought so 4:20 much real estate in my own portfolio and 4:22 how I am the sole owner today. Now, if 4:25 you don't attach an option contract and 4:27 you don't have a fixed price to buy your 4:28 partners out, you can still buy them 4:30 out, but it's going to be total 4:31 negotiation in the future. You don't 4:33 know how expensive it will be. You don't 4:34 know if they'll agree to it. It is a 4:36 best practice to put these in place in 4:38 the beginning of your deal. Now, what 4:40 happens at the end of 5 years? If the 4:41 partnership's been fantastic, you love 4:43 working together. Well, guess what? The 4:45 option contracts optional and anything 4:46 you put in writing as long as all 4:47 parties agree can be renegotiated. If 4:50 you guys get to year four and you 4:51 decide, hey, we love this partnership. 4:53 In fact, we want to go buy more 4:55 buildings in this partnership in a 4:56 similar structure, you can go ahead and 4:58 amend your operating agreement, cancel 5:01 out the option agreement and its 5:03 associated penalties and move forward 5:04 with a new partnership. The beautiful 5:06 thing about option contracts is it gives 5:08 you options, but it also gives you a 5:09 path to own your portfolio, SANS, any 5:12 partners. is a beautiful, beautiful 5:14 agreement that gives you fixed 5:15 timelines, fixed prices, set terms. Add 5:19 this to every single partnership you 5:21 have. Don't design your partnerships to 5:23 be a marriage. You do not want to be 5:25 partnered with everyone forever. You do, 5:28 in fact, want the ability to control 5:30 your real estate. You found the deal, 5:32 you lined up the capital, you got them 5:33 their return. Keep the real estate. 5:35 Okay, let's talk about the second use of 5:37 option contracts. And this one's super 5:38 interesting, by the way. If you have a 5:41 deal that does not cash flow day one, 5:42 and by the way, our rules for real 5:44 estate are buy deals that cash flow day 5:46 one no matter what. We buy a deal, our 5:49 income goes up. Period. Full stop. But 5:51 what if there's an underperforming 5:52 property and the owner won't let you get 5:54 creative with the finance to a place 5:56 where you can get the deal to cash flow? 5:58 Essentially, what I'm saying is what if 5:59 there's no deal structure available that 6:01 gives you the cash flow you need and 6:02 gives the seller everything they want. 6:04 They want too high a price. they only 6:06 are okay getting cashed out. So, they 6:07 need bank financing or a check for the 6:09 entire dollar amount. We solve this with 6:11 the option contract. We can actually do 6:14 what's called a management option 6:15 contract. Very similar to a lease 6:17 option, but in this case, I get 6:19 management of the entire building with, 6:21 you guessed it, an option contract to 6:24 purchase at a fixed price and a fixed 6:25 period of time. So, if a property is 6:27 underperforming, the owner is having 6:29 difficulty getting it into a position 6:30 where it would be bank financeable, you 6:33 can take control of the property through 6:34 the management agreement. You'll 6:36 typically pay an option fee, which again 6:38 can be structured out of your own money 6:40 or out of raised capital like our first 6:42 example, but you bring in an option fee. 6:45 You take control of the building. In 6:47 this one, you would write a business 6:49 plan for them and say, "This is how I 6:50 intend to get this property in a 6:52 position in which we can get the bank 6:54 financing to get you your price." If 6:56 it's a property where the price is good 6:59 in the future if the property was doing 7:01 better, this gives you a solid chance to 7:03 execute your business plan and close on 7:05 the seller's terms. Now, typically you 7:08 want to negotiate for seller financing 7:09 or or another creative route. This 7:11 option is only to be used if there's no 7:13 other way to do it. Ultimately, the goal 7:15 and what you really want to happen is 7:17 the day you guys come up with an 7:18 agreement, you go under contract and you 7:20 own the property. If there is not a way 7:22 to do that, but you do love the deal, 7:23 and you believe in your business plan, 7:25 this is a way that you essentially can 7:26 put a pin in the map and say, "I know 7:28 when I'm acquiring the property. I know 7:29 what I have to do to make the property 7:31 worth equal to or greater than the price 7:33 that they want." This gives you control 7:35 of the property. The option contract can 7:37 be used to buy the real estate in the 7:39 future. And again, this can be done no 7:40 to low money down. Honestly, I don't 7:42 know why more channels don't talk about 7:43 the option contract or the creative ways 7:45 to use it. This is how you buy massive 7:47 amounts of real estate when you have 7:49 literally no money or just less money 7:51 than the amount of real estate that you 7:52 want to buy. If you want to learn more 7:54 about creative finance and how to master 7:55 this game, buy properties with or 7:57 without money, follow this channel right 8:00 here. If you haven't done it yet, click 8:01 that subscribe button. I will see you on 8:03 the next
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