Finance Roll

Situation: A Land Developer, Mr. Tierra, has located a large parcel of land that he would like to develop into smaller tracts (5 acres each) for which there is a great demand.The land totaling 640 acres is owned by Mr. Grande who has had the land on the market for some time with no success in finding a qualified buyer. Mr. Grande does not want to finance the land for a buyer. It is difficult to find a lender who will lend on raw land. Mr. Grande's firm price on the land is $1,000 per acre.

Mr. Tierra can raise the cash to buy 40 acres of the land and put in the improvements; roads, water, septic tanks, electricity, etc.

Possible Solution:

1. Mr. Tierra will buy 40 acres for $1,100 per acre, cash payment.

2. Mr. Tierra negotiates and buys an Option from Mr. Grande to purchase the remaining 600 acres in 40 acre or larger parcels over the next 5 years at a price of $1,100 per acre.

3. Mr. Tierra pays $4,000 for the Option which will be credited toward the purchase of the last 40 acre parcel.

Let's look at some of the benefits for both parties.

Mr. Tierra:

1. Is able to start the development of the first 40 acre parcel which he can afford to do, wherein, if he had to purchase the entire 640 acres he could not do it.

2. By developing the first 40 acres, Mr. Tierra will increase the value of the remaining land because he has now built the popularity of 5 acre parcels being available.

3. Developing and selling the first 40 acres in 5 acre tracts will provide additional funds to buy and develop the next parcel of 40 acres or more.

Mr. Grande:

1. Receives a cash price of $1,100 per acre. He could eventually receive an additional 64,000 cash for the land.

2. Receives $4,000 as Option Consideration which he will not have to pay tax on until the final parcel is purchased or the Option is not exercised.

3. Each sale will be on individual parcels and not the entire 640 acres; therefore, Mr. Grande does not have an installment sale and will only have to pay taxes on each parcel as it is sold.

4. The development of the first parcel by Mr. Tierra will increase the value of the remaining land. If Mr. Tierra does not exercise any portion of the Option, the remaining land will be more valuable. Plus, Mr. Grande gets to keep the $4,000 Option Consideration.

Now let's look at another example of how this concept could be used on a smaller scale.Let's say that Mr. Charles, an experienced Home Builder, wants to build some Spec houses and needs lots on which to build them. He has funds to build the first house, but can't buy several lots at the same time. Mr. Charles, through a realtor, locates a Mr. Apple who owns 20 lots in a Residential Subdivision. As in our other example, Mr. Apple wants to cash out of the lots, but is in no great hurry to do so. He also doesn't want to finance the lots to a builder who is building Spec houses. The builder could go broke and leave the lots tied up in legal actions.

The Realtor, who had been to an Option Seminar, proposed the following solution: 1. Mr. Charles will purchase an Option To Buy the 20 lots. The Option terms allows him to take down lots one or more at a time by paying cash for the ones taken down. 2. Mr. Charles will pay cash for the first lot. This allows him to do all the things necessary (permits, site work, etc.) and build his first house. With the return of his funds plus profits from the sale of the first house, he can buy the next one or more lots. 3. This allows Mr. Charles to "Roll" through all 20 lots over a period of time which he can afford to do. 4. Mr. Apple gets cashed out of his lots and does not have to worry about the builder being successful. 5. In the event the builder does not complete the purchase, the remaining lots should be more valuable. 6. Mr. Apple will only have to pay income taxes on the funds as he receives them and not on the entire proceeds from all 20 lots at one time.

These posts are the opinion of the author who is not engaged in rendering legal, accounting, or investment advice. If such advice is required or desired, the services of competent professional persons should be sought.