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Profiting from Real Estate Option Contracts

Experienced real estate investors can use their self-directed accounts to take advantage of a range of attractive opportunities.

This example concerns significant profits from an option contract.

When Lynn opened her Entrust self-directed account she rolled her Diamond Shamrock Pension plan into a traditional IRA, and then converted it to a self-directed Roth IRA. As our story begins, the value of that IRA is about $100,000.

Lynn was an experienced real estate investor, and always on the lookout for appreciating properties. Her strategy was straightforward: find an undervalued property, make an offer based on her knowledge of the real estate market, rehabilitate the property, and sell for a target profit of 25 percent, less closing costs.

She found a property belonging to Ralph, who wanted to move to a warmer climate on retirement in the not-too-distant future, and who didn’t want to hang on to an unimproved property, for which he had originally paid $25,000.

Lynn thought this was a great opportunity, and negotiated to place a $10,000 option to purchase in consideration. The purchase price negotiated with Ralph was $175,000, and was set to expire in ninety days. If Lynn did not buy the property for $175,000 at that time, Ralph would keep the $10,000. There was little doubt in Lynn’s mind that she would buy, as she was a seasoned real estate investor who always did due diligence on properties, and she knew the property was undervalued. She had already found a buyer who would pay her $425,000 for it, without improvements!

Considering that this would increase her current IRA asset balance for just this transaction from $100,000 to almost $205,750 after closing costs and commissions of $44,250 it wasn’t surprising that Lynn felt energized. Plus, with this increase in value her self-directed Roth IRA would subsequently be able to acquire properties or other assets without debt financing. Using her IRA funds as the consideration for the option, she would be able to execute the purchase of the property, and shortly thereafter sell for the profit.

Lynn had her self-directed Roth execute the option contract with Ralph, within the 90 day time period for the agreed on price of $175,000. On closing, Lynn had her Roth enter into a Sales agreement for the property with Yvonne, the buyer who was ready to pay for the property without improvements. Yvonne was not able to find financing for the property, but had sufficient cash to pay $100,000 down. Lynn, through instructions to her Roth IRA administrator, agreed to carry back a mortgage for the balance of $325,000 in Lynn’s self-directed Roth.

Lynn sold the property to Yvonne on the terms and conditions they had agreed to. The payments to be made to Lynn’s self-directed Roth at 10% interest for a period of 15 years.

Result? Lynn succeeded in increasing the cash in her Roth by $100,000 and also having a cash flowing note at the same time.

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