This is one of the most important lessons in my program, so make sure everything is clear to you. Earning money as a real estate investor hinges on making smart offers on properties. Though high offers submitted may be eagerly accepted by sellers, they will also result in your losing or making little money on those properties. Submitting offers that are too low may result in great profit potential, but they are rarely accepted, so the profit potential remains just that — potential. To make money as a real estate investor you have to actually buy and sell property. The trick, then, is to submit as low of an offer as possible while retaining a good chance of being accepted.
Actually, making the proper offer on a property is not a trick but a skill. So the question you need to be asking is: “How can I gain this skill?” Two overarching elements will make it happen: 1) accurate information; and 2) accurate information
With this goal in mind, however, it is crucial that you understand that ‘price’ is more important than ‘acceptance.’ As a savvy investor you must always be willing to walk away from a deal if you do not get a satisfactory price. If you bid low and your bid is rejected, you lose no money. To effectively put to use. It is my job to supply you with the accurate information. It is your job to effectively put it to use.
In this chapter we will explore reality-based principles and practices whereby you can repeatedly attain a 30-50% margin of profit. As we tackle real life “what if” situations and worst case scenarios, you will discover what to do to assure handsome profits even in the face of the unexpected. We will put on our math hats (or pull out our calculators, if you prefer) to figure out how to arrange the $$$ numbers that make for a full-bodied bottom line. I will also lead you step-by-step through live purchase transactions so that you can taste and smell what it feels like to make a winning deal.
REVIEWING VALUATION ELEMENTS
One factor that directly affects the value of property, and consequently, the amount of money you should offer, is repairs. The last chapter gave you a thorough education on how to inspect properties, identify needed repairs, then calculate costs for those repairs. Now let me add a piece of hard earned wisdom: When it comes to repair costs, expect the unexpected. I remember many instances when hidden repairs arose with a property, such as cracked pipes behind a wall, that I could never have discerned from my initial inspection. Some defects will simply not be found until you actually start working on the home. So while my profits were hurt by repair surprises on numerous occasions early in my career, a positive result was that my offer submitting IQ went up! I began integrating worst case numbers for repair costs when calculating my offers. This usually means somewhere between $3,000 and $5,000 more than apparent repair costs.
If there ends-up being no hidden repair costs, the “bad news” is that I make an extra 3,000-$5,000 profit! So remember, one ingredient in ensuring a good return is to always figure worst case repair costs.
While we are on the ‘repairs’ issue, don’t forget to ask your contractor to up his bid by the amount necessary for you to cover any interest-only payments you may need to make to your lenders, as discussed at the end of Chapter 1.
Another pre-offer estimation that needs careful consideration is the market value of the property. I remember the first property I ever bought; I thought I could resell it for $130,000, but the appraisal resulted in a value of $95,000! I was so upset. I should have made $35,000-$40,000 on the deal, but only made about $1,000. Trust me, this was my fault. The property I purchased was a REO, and the Realtor told me that I could resell it for $130,000. What was my mistake? I didn’t do my homework and get sales comparables. Rather, I relied on the Realtor. I thought to myself, “This guy wouldn’t lie to me.” But in the end, I discovered he did. The lesson? Never trust a Realtor or any third party; always do your own research.
Please understand, I was new in the business. I had no one to point me in the right direction and show me how to avoid these pitfalls. But you are the lucky one. You are learning from a pro and won’t have to make the same mistakes I did, because I am showing you step-by-step how to make a fortune in this business. All you have to do to accurately determine the fair market value of a property is methodically work through the steps I outlined and detailed in Chapter 3, “Property Inspection and Valuation.”
WORKING THE NUMBERS
The next step is to consider the closing costs associated with purchasing the property and with selling it. When you purchase a property, total closings will be between $2,700 and $3,500. If you are using hard money lenders, however, they will increase this amount by charging you between 3 and 5 points. One point equals 1% of the loan amount. To avoid paying points, I highly recommend using a private investor.
While my private investors charge me a $2,000 fee when I sell the property, they charge me no points up front. I know other investors who use private investors, and also pay no points. It’s all a matter of negotiating with your private investor. To find private investors, use the techniques I shared in Chapter 1, “Acquiring Financing.” As an investor involved with both buying and selling property, you will need to calculate closing costs associated not only with buying but selling. In my program we pay for the buyer’s closing costs and down payment by using a nonprofit organization, such as AmeriDream. Though this may seem like a strange, profit draining practice as you first consider it, once you read the details in Chapter 5, you’ll discover it is actually a powerful profit making strategy. I came upon this strategy as a result of the area I work: a lower income area in which people don’t normally have the money to purchase a home.
It helps my find buyers and sell homes in a snap. You, however, may work a middle-income or high-income area, where people have money and don’t need you to pay their fees. Even so, keep one thing in mind — if a buyer had to choose between two identical houses, the only difference being one seller is willing to pay their down payment and closing costs, which house do you think the buyer will take?
That being said, a quick way to calculate total closing costs for both you and the buyer (closing costs are normally accrued for both buyer and seller) is to take the loan amount and multiply it by .08 (8%). So if the loan amount is $170,000, total closing costs in the sale of the property would be in the range of $13,600 (if the buyer gets a FHA loan).
Another consideration for real estate investors like you, and the consideration which likely weighs most heavily on your mind is, “What kind of profit should I expect in this business?” There is no clear-cut answer, but my intention is to make at least 30% net profit (the profit which remains after all expenses are paid) on each deal. No two investors, however, are the same. Some are happy making 15% to 20% and being able to sell the property in three months. I know other investors who aim for the stars and will only look at properties that can give them at least 40% or 50% return. Because no boss is looking over your shoulder, there is no set return you have to make. The question is, “What do YOU want to make?” Once you get going and begin submitting offers, you will see offers higher and lower than yours. This is not reason for concern. It is simply that some investors want to make more than you, while others are satisfied with a smaller profit.
Another thing I do before presenting an offer is to check if I have any competition. If I do have competition, I bid for a 30% to 35% return. If no competition is apparent, I shoot for a 40-50% return. Why? When you’re competing only against yourself, there is nothing stopping you from aiming high; but because competitors lessen your chances of winning the bid, you need to make your bid more likely to succeed by decreasing it.
REO Bids
Due to the nature of the bidding process, your first bid should often reflect a profit potential which exceeds what you really expect to make. For example, when I put my first offer in on a REO, my bid is low enough so that I would make a 45%-50% return if the bid was accepted. When the Realtor presents the offer to the bank, 99% of the time, they will not accept it as is, but will counter with another offer. Because of this, your first offer should be on the low side—just to feel the bank out. They may counter with a much higher price or a price very close to your initial offer. If their initially stipulated price is very close to your first offer, either counter with another offer which is half of the difference or accept it straightaway. Either way you are the winner!
If the bank’s initially stipulated price is much higher than your first offer, my practice is to reduce my calculated profit by 5% and present a corresponding counteroffer. In other words, if your first offer is based on an expected profit of 50%, your counteroffer should be based upon a 45% return. One thing NOT to do is submit a counteroffer with a huge decrease from their first price. If you do, the bank will not take you seriously.
Some banks will come back to all investors and ask them for their highest and best offer. This is usually done when multiple investors are bidding on the property. As competition does exist in these situations, make your bid accordingly.
Privately Owned Property Offers
On the other hand, when dealing with distressed properties that are not owned by banks, such as pre-foreclosures, probate, and divorce, 9 out of 10 times you will have no competition, at least based on my experience. As a consequence, your initial and subsequent offers should represent healthier profit margins. In many instances, outrageous profits are possible, as these owners are in need of someone to buy their homes. If you don’t buy their home, these owners may not only lose their homes, and the years of labor and money they invested in their homes, but may come away without a dime, and with a credit history that is mortally wounded.
The actual amount of profit which should be figured into any privately owned distressed property offer will vary widely, as the situations pertaining to each particular deal will vary widely. Obviously, the degree of desperation the owner is in bears strongly on how much profit you can expect. A divorcing couple may decide to hold out for a price near or at market value. In that case, you would simply have to say, “Thanks, but no thanks,” and keep on walking. On the other hand, an out-of-state owner whose property has been abandoned and is in disrepair, may well be willing to get rid of it for 30% of its post-repair value. Depending on the extent of the repair requirements, this could easily fall into the 30-50% profitability range. The point is, with these types of properties, you have no choice but to investigate and assess them individually prior to making an offer (as I will show you in the two case studies below). Be prepared for big money. But also be prepared to walk away if the deal is not sweet enough.
Regardless of what price a distressed property owner may begin the negotiation process with (and you should have them initiate the process), remember: negotiations are just that — negotiations! This means it is expected that you will present a counteroffer.
So don’t be afraid to haggle. Expect to haggle. Look forward to it. Get used to it, and get good at it! Negotiating is truly an art. It comes from practice. You will be getting a primer on the art of negotiating as you walk with me through the two live samples. What I am doing here is giving you a foundation and letting you in on my method of submitting offers. But again, it all comes down to what you are comfortable making on a property, knowing your competition, and being familiar with the particulars of any given deal. I would encourage you not to settle for small change. Don’t be one of the few investors who is happy with a mere 15% to 20%.
Sample Offer Submission #1
Now that we’ve gone over the basics, let me show you an example from an actual deal I transacted some time ago. I work with a number of investors who come to me with properties, hoping to assign their contracts to me for a fee. One particular investor approached me, we’ll call him Fred, saying he had a three family unit for $69,000. After he gave me the address, I knew I could sell the property for $150,000-$160,000, because I had purchased and sold many homes in that area. My next move was to go examine the property. A full inspection revealed that net repair costs would be around $23,000- $25,000. I then began to work the numbers: “Say I give Andy his $69,000; I’ll figure repairs on the high side, $25,000, along with the $3,000 buffer (which I discussed earlier in this chapter). Closing costs to purchase the home will be about $3,200.” The calculation, then, looked like this:
$69,000 (purchase price)
+ $25,000 (repairs)
+ $ 3,000 (repair buffer)
+ $ 3,200 (closing costs)
= $97,000 (total expenditures on the purchase)
I knew I would use my private investor who charges me 20% interest. So,
$97,000 (loan amount)
x .20 (20%)
= $19,400 (total annual interest)
$19,400 (total annual interest)
÷ 12 (months)
= $1,617 (monthly interest-only payments)
As my standard time span for selling a home is three months, I figured I would pay my lender a total of $4,851 in interest ($1,617 x 3). So far, then, costs would total:
$ 69,000 (purchase price)
+ $ 25,000 (repair costs)
+ $ 3,200 (closing costs for purchase)
+ $ 4,851 (interest-only payments)
= $102,051 (total costs)
As stated previously, I knew for a fact that market values in the subject area were $150,000-$160,000. Because I would be paying the buyer’s down payment and closing costs, I knew I could sell the property for $160,000. The added enticement of payingthese upfront costs typically allows you not only to sell the house quicker, but to sell it for a slightly higher total price. If I was not paying these fees, I would anticipate selling the home for $150,000. As closing fees normally run at 8% of the sales price, those fees will total about $12,800 ($160,000 x .08 [8%] = $12,800). We can then subtract that $12,800 from the sales price of $160,000, leaving us $147,200. From $147,200 we will subtract the total costs figure of $102,051, the result being $45,149. This is my potential net profit. To calculate what percentage of return this is, do the following:
$45,149 (potential net profit)
÷ $102,051 (total costs)
= 44%
While 44% is a great return, I didn’t settle for it. Why settle for great when you can have greatER? So I refused Fred’s offer of $69,000 and offered him $57,000 after I walked through the property with him and pointed out all the negatives. After much negotiation we settled on the price of $60,000. Is that sweet or what? So as you can see, I could easily make another $9,000 on top of the $45,149 — over a 50% return! I am repaired the above mentioned property. Per my contractor’s proposal, the total repair costs will equal $24,500, which is almost exactly what I had estimated from my first inspection of the property. As for the buyer, I had him lined-up before I even purchased the property, and we are currently under contract for $165,000.
The appraisal of the property came in at $172,000, significantly higher than I anticipated, due mainly to the fact that all repairs have been completed. The final approval of the buyer’s mortgage took two months! Yet…Do you know why this deal worked out so well for me? I can tell you: accurate information effectively put to use. I was familiar enough with the particulars to see the end from the beginning. I knew the turf; I knew the neighborhood; I knew the owner; I knew my private investor; I knew the post-repair market value of the home; I knew how to estimate repair costs; I knew how to calculate costs versus selling price; I knew my contractor; I knew how to haggle — and having this knowledge I then ACTED. Did you notice how I established a big buffer for myself with that potential return greater than 50%? For this reason, when you are just starting out, I recommend you work with a potential return of at least 40%. This significant financial buffer will serve to protect you in case you miscalculate repair costs, market value, or some other crucial figure. If you end-up being accurate in all your cost projections, then all the better for you, as you will make more money.
So remember, always do your homework. Write all the financial projections down on paper just as I showed you. As you get more experienced in the business you will no longer need to jot down your figures; you’ll be doing the calculations in your head, determining your potential profits on any given deal in as little as a minute!
Sample Offer Submission #2
The sample submission above was a purchase from another real estate professional, using private investor financing, and concentrated largely on the numbers.
In this sample I will be working with a homeowner, showing you how to interact with a private seller on a personal and professional level. You will discover successful methods of speaking with owners of distressed property, and what to do and not do as you consider making an offer on their house. What you do after contacting homeowners are some of the most important things you’ll do in this business. The home we are going to inspect is owned by Mr. Wong. He was issued a Notice of Default four weeks ago and has since been notified that his home will be put up for auction in three weeks. He has to vacate the premises no later than two weeks from today. Mr. Carter, as you might suspect, is under considerable duress.
My preliminary research has revealed that the post-repair value of his property should be about $150,000. By way of a primer, when you go to a homeowner’s house to inspect the property and consider the feasibility of making an offer, your basic objectives are twofold:
1) inspect the property to better assess its value, and
2) get the owner to accept as low of an offer as possible.
As for objective #1, you will already have a good idea of the value of the property before you put foot on it. Why? You will have done your homework. You will have gathered values of comparable homes within the vicinity and have records of those comps on file in the trunk of your car. You will have interviewed Mr. Wong by phone and know the balance on his mortgage, how many payments he is behind, whether he owes back taxes, if taxes are included in his mortgage payment, and when his property is due to be put up for auction (just as I taught you in Chapter 2). You will also know exactly how much equity Mr. Wong has accrued. If he had less than 40% equity, you would not be taking the time to inspect his home. If Mr. Carter was uncertain of the monetary figures pertinent to his mortgage, or in your opinion was incompetent or untrustworthy, you would bring along an “Authorization to Release Mortgage Information” for him to sign.
As for objective #2, just peek over my shoulder as I pull my car to the curb in front of his house. (Note: My words and actions will be spelled out in regular print, while my thoughts and/or motives will be seen in italics.) My appointment to view the property was scheduled for 2 PM. I arrive at 2 PM.
Successful professionals are not early and not late. I greet Mr. Wong with a smile and a warm handshake. The face of a real estate professional who may well save him from personal and financial catastrophe is a well received gesture. “It’s great meet you in person. I’m sorry to hear how the situation has gone with your house. But hopefully, I can help you out.”
Mr. Wong needs to know two things about me:
1) I am a professional real estate investor, and
2) I can save him a lot of personal and financial grief
IF I can cut a good enough deal on his house to profit from it. “So the auction is still scheduled for three weeks from today? And you have to be completely out of here within two weeks?” You must continually keep one fact in front of the pre-foreclosure homeowner: The auction is impending and little time remains to make a deal on his home. “Yes,” he says, looking down to the ground.
“As I mentioned on the phone, I need to do a walk-through of your place to determine what kind of shape it is in and whether it would be profitable for me to take it off your hands.” At this point, I retrieve a pad of paper and a flashlight from my back seat, tuck the flashlight under my arm, pull a pen from my pocket and begin walking up the driveway. You must show by your actions and preparedness that you are who you say you are — a professional real estate investor. As we make our way up the driveway, I point out a number of large cracks and small weeds growing up through them, saying, “This is going to require some attention,” while at the same time writing notes on my legal pad.
Continuing on through the front yard, onto the porch and through the front door, I make regular notes of all the things that will need refurbished. This serves to prepare him for the fact that the property is not worth as much as he thinks.
While we tour the place, I review the mortgage situation with Mr. Wong, hoping to confirm or disconfirm the information he gave me over the phone. If there is any question in my mind as to the accuracy of his disclosures, I will ask him to sign the “Authorization to Release Mortgage Information” form which I brought along.
Stopping in one of the bedrooms, I stand on a wooden chair, pop-up the opening of the attic access and shine my flashlight around looking at the condition of the structural trusses, and the type of insulation which is in place. Satisfied with my exam, I close the access, look down at Mr. Carter and ask, “So how much are you hoping to get out of this property?” He fumbles, then says, “$135,000.” After a slight pause, I calmly inform him that after considerable research of comparable housing within the area, the fair market value for this property is substantially lower than that. That fact doesn’t seem to settle well with him. I don’t say anything more about price at this point.
I want to let the idea sink in that his house is not as valuable as he thinks, but I do not want to tip my hat by saying exactly what I am willing to give for the house, yet. Along with telling him his property is worth less than he thinks it is, I continue pointing out all the negative aspects to the house — all the things which need repaired or refurbished. Even if you don’t see a lot of things wrong with the property, it is good to still take many notes, as this gives the homeowner the distinct impression that things aren’t as good as they could be. We have now made our way out the back door.
Looking up to the roof, I comment, “Looks like the roof is due for new shingles.”
Anytime significant or expensive repairs are noticed, be sure to speak of them out loud, as the homeowner needs to be very aware of them.
After we have examined the entire property — interior, exterior, roof, attic, basement, garage, and landscaping — I say, “You know, Mr. Carter, you are in a tough situation. I am hoping to help you out. But I am a real estate investor. My aim is to make a profit on this property. But I can tell you right now, that this place needs a lot of refurbishing to put it in marketable condition. And refurbishing costs money. Do you have any idea how much it will cost to put this property into marketable condition?”
Allow him to answer. While most homeowners are not good at estimating prices for repairs, this can work out to your benefit. How? When they guess a monetary figure, they may guess high! Mr. Carter guesses that it will take about $35,000 to get his property into marketable shape. I nod my head in agreement, though the figure I had in mind was about $10,000 less! As Mr. Carter has now tagged an actual monetary figure to repairs, he is even more prepared to take a lower price for his house. You are finally ready to talk price. One of the secrets of negotiating is never stating a price up front, and if possible, always requiring the other person to name a price first. “So Mr. Wong, how much money do you NEED from the sale of your property?”
Notice: I did not ask how much he WANTS, I asked how much he NEEDS. He will WANT as much as possible. What he NEEDS is a different story. “Well,” he begins, “though I wanted $135,000, I see that there is quite a bit of work to do around here to fix it up. So I guess about $100,000 will do the trick.”
At this point I say, “I think it’s important for you to think about a few things, Mr. Wong. For one, only three weeks remain before this property is auctioned off. You have to be out of it in two. Once your house is auctioned, you will lose ALL the equity you have built up over the years; you will lose your good credit and will not be able to borrow money from virtually anywhere; you will certainly not be able to purchase a house for many years. You will be out on the street with no money in your pocket and nothing to show for all the years, labor, and money you have invested in this house. BUT if you sell me your house for a good price you can walk away from all these troubles AND have enough money for moving expenses, enough money to rent an apartment, and still have a lot left in your pocket!” This little speech will set him on his heels. You have to make it clear that he has two basic choices:
1) hold out for too much money and end-up losing everything, or
2) sell to you for a good price and walk away a winner. I add, “Are you willing to reconsider that price you gave me?”
If he continues to hold out for his $100,000, or does not drop his price significantly, I remind him of all the expenses I will incur in the process of transacting this deal.
“You have just two choices: allowing the property to go to auction and walking away with nothing, or selling to me and walking away with money. But for me to go through with the deal, I will have to make enough to pay for all the expenses I will incur. Along with the cash I give to you, I will need to pay closing costs, reinstatement fees, repair costs, monthly payments, taxes, and insurance. If you want to walk away with money, you’re going to have to make the deal friendlier for me.”
Mr. Wong says he’ll sell me his home for $80,000. Looking him squarely in the eye, I counteroffer with $45,000. One of the secrets of haggling is looking the other person dead in the eye. There is something about doing that which makes them know that you are serious, and that you are not a push-over. He says $70,000. I say “$65,000 is my final offer.” He agrees. from him again. If you do the math, as exemplified in the previous example, you will see that I stand to make some $52,000, a 53% profit!
Here’s the breakdown:
$65,000 (purchase price)
+ $25,000 (repairs)
+ $ 3,000 (repair buffer)
+ $ 3,200 (closing costs)
= $96,200 (total expenditures on the purchase)
$96,200 (loan amount)
x .20 (20% loan interest rate)
= $19,240 (total annual interest)
$19,240 (total annual interest)
÷ 12 (months)
= $1,603 (monthly interest-only payments)
$65,000 (purchase price)
+ $25,000 (repair costs)
+ $ 3,200 (closing costs for purchase)
+ $ 4,810 (3 months interest-only payments)
= $98,010 (total costs)
$51,990 (potential net profit)
÷ $98,010 (total costs)
= 53% (profit potential)
It is time to put this deal into writing. You can see how this is done via the “Contract for Sale and Purchase” form. (Look in the forms section ) As a real estate investor who is continually buying and selling properties, carrying a blank sales/purchase contract with you is as important as your wallet. One of the most important features of the sales/purchase contract is the clause that you can and should write in just above your signature at the bottom. Notice on the included contract that there is a handwritten comment, just above the signature section, stating, “Seller agrees to allow buyer to inspect the property along with any contractors or partners.” Adding this clause allows you to bring in potential investors who you might want to joint venture with or assign your contract to. Any handwritten portion of a contract supercedes the original typed print. Further, if you ever come across portions of a contract you are unsure of or want to exclude, it is fully legal to cross them out before signing. But remember, any additions or deletions from a contract must include the initials of both signing parties for them to be legal.
After the contract is signed by you and the owner, give the homeowner a check for his agreed upon deposit amount (again, I don’t give over $1,000). Once Mr. Wong cashes this deposit check, the contract is legally binding.
Contract for Sale and Purchase
SAMPLE CONTRACT
There will be instances when a seller wants you to submit your offer in writing prior to his actually accepting the offer. When this happens, the form to complete is the “Offer to Purchase Real Estate,” which is included on the next page. I suggest you insert the same provisional clause that you did in the “Contract for Sale or Purchase.” That is, right above your signature, handwrite the following: “Seller agrees to allow buyer to inspect the property along with any contractors or partners.” As with the sales contract, adding this clause will give you the option to bring in potential investors who you might want to joint venture with or assign your contract to.
After completing the offer to purchase form, just mail or fax it to the owner.