You’ve probably heard about buyer remorse, where at some point in the purchase of a home the buyer regrets their decision to either buy, or not buy. Optionee remorse is similar, but drawn out over a much longer time frame.
An optionee, in this discussion, is a person who has negotiated a purchase price today for a purchase they will make sometime in the future, say, a year from now. In an appreciating market, setting a price today can potentially mean you will be buying below the then-market value, assuming the market continues to go up. In a declining market, negotiating a price today, trying to take into account what might happen in the future is an obviously risky thing. How risky depends on the terms of the option.
Last year in August, I negotiated a $2.3m home purchase to take place one year later, now in mid Aug 2007. During this yearlong period, my client would rent the house, with 100% of the rent ($9k/mo x 12 months) applied towards the eventual purchase. There was also an up-front payment to the seller of $48k, also to be applied to the purchase.
Now, by definition, an option to purchase is just that, an option. The buyer can choose not to go through with the deal (i.e. not exercise the option). But in this case, not exercising the option meant the buyer would walk away from a total of $161,000 in credits towards the purchase (all the rent, plus a $5k security deposit, plus the $48k option money).
Of course, walking away from $161,000 in purchase credit is no small thing. But it might make sense if the market has gone down during the period of the option. $161,000 divided by the $2,300,000 purchase price is 7%. Has the market for luxury homes in this neighborhood gone down at least 7% in the last year? This was a hard question to answer, namely due to the paucity of similar inventory. Intuitively, it seemed like it had, so the price negotiated a year ago seemed too high for today’s market. The buyers felt like they would be significantly overpaying for the house, and rightly worried whether they could get their money out if they had to sell within a few years.
Oh, another wrinkle: the jumbo mortgage market was melting down. Luckily, the buyers had locked in a great loan rate for the option house, but if they purchased any other property, the interest rate would have been several percentage points higher.
Given all these market changes that had occurred over the last 12 months, the buyers felt like they had a good argument to make asking the seller to lower his price, to $2,100,000. Unfortunately, the seller wasn’t as pessimistic about the market as the buyers were. We were told to exercise the option on its original terms, or walk away.
You start to see the buyer’s conundrum, and the cause for remorse. Should they exercise their option to purchase (they do love the house, by the way), or go back into the marketplace and hope to make up the $161k loss by finding a comparable house at today’s lower prices? This amounted to the perfect storm of anxiety for the buyers.
What happened? Over a period of several weeks, the buyers looked at every other house on the market, none of which sufficiently appealed to them. So they decided to stay put, exercise the option, and hopefully not have to sell the house anytime soon.
But this seems that this approach will become a self-defeating proposition. Demand is indeed high, but relatively steady. As supply increases, buyers may begin to feel less desperate to buy any one house because there are more on the horizon. This is likely to lead to lower prices. So hang on buyers: the Inventory is coming!