Thursday, February 26, 2015

Investor Offers Are Low-Ball!

Everyone wants the best price they can get.  Investors are no different.

But neither is the homeowner.

So investors often get accused of "low-balling" the seller with their offer.   A significant reason for this is investors fail miserably in presenting the offer.  This is another reason investors are often seen as "taking advantage" of a seller's poor situation (deferred maintenance, pending foreclosure, etc.).

But the fact is, the cash offer we make is the offer we make because we HAVE to make that offer.  There is a tried and true formula in real estate for quick-close cash-offers that significantly reduces (although does not eliminate) the possibility of losing money on the deal.

The Formula

Most investors are familiar with this formula... (ARV * .70) - repairs.

Let's break that equation down.  ARV is an acronym for After-Repaired-Value.  I think this is a misnomer as I'm not only interested in the repairs to a property, but also updates and aesthetics, but regardless, you get the idea.  What will the home sell for after we make it look brand-new?

Let's say we pull-comps (we compare the subject property to other recently sold and rehabilitated property) and determine the ARV is $200,000.00.  We then multiply that number by 70% and subtract out the costs we are going to incur to make it look new.  If that numbers is $40,000, then our MAO (Maximum Allowable Offer) is $100,000 ($200,000 * .7 = $140,000 - $40,000 = $100,000).

That formula will save you thousands as even surprise repairs won't mean losing money on the project.

Making the Offer the Wrong Way

Most investors will do this math and then present the offer to the homeowner.  "Mrs. Homeowner, I can offer you $100,000.00 for your property."

It's no wonder investors are accused of "low-balling".

You have to understand, there is no more price-sensitive market than real estate.  The homeowner already has a good idea of what homes sell for (granted, fixed up pretty homes) because they drive through their neighborhood every day.  And when a home goes on the market in their neighborhood, it's a good bet they have pulled a flier, looked on Realtor.com or Zillow, or otherwise determined what the asking price is.

The homeowner probably understands their house isn't as "pretty" as the neighbor's house that has been listed for $200,000.00.  But when you offer $100,000 for the house, that must sound really low!

You have to remember, the homeowner isn't an investor.  They probably haven't thought through issues like carrying-costs, upgrades, age of roof, etc.  And they know it's not going to cost $100,000 to fix their house!  So why are they taking (in their mind) a $100,000 discount on their property?!

Presenting an offer in this manner significantly increases the odds you are about to get kicked out of the home, accused of being a "low-baller" who is trying to "steal" their home.

Making the Offer the Right Way

A better approach is to offer an explanation of your offer as you present it.  This is how I present the offer:

"Mrs. Homeowner, I love this home and I am excited that I can make it look and fresh and let a brand-new family move in here and enjoy it for years.  But, I'm an investor, and there is a tried-and-true formula investors have used for decades when making a cash-offer on a home.  All investors use this same formula.  I look at the price I think I can sell the home for when I am done doing all the updating that it needs... in other words, I want to make this home look like 2015, using all the modern and fashionable colors, schemes, trim, fixtures and such.  I want it ready to compete with the brand-new homes down the street.

"I think after I do all that, I can get $200,000.00 for the home.... would you agree?

"I take that number and multiply it by 70% and then subtract out the cost of the updating.  I know that 30% sounds like a wide margin, but I am going to lose 18% on the buy, carry and sale of the property, so that allows me to make roughly 12% for my time and money.

"So $200,000 times 70% is $140,000.  I think its going to take me about $40,000.00 to bring it completely up to date and make it look brand new.  Therefore, the cash-offer for this property is $100,000.00"

Breaking down this speech

I want to break this down as there is a lot of nuance in this speech.

"Mrs. Homeowner, I love this home and I am excited that I can make it look and fresh and let a brand-new family move in here and enjoy it for years."

People love their homes.  I do too.  They love the idea that someone is going to get to enjoy the home as much as they did.  I want to start the speech by putting that image in their mind.

"But, I'm an investor, and there is a tried-and-true formula investors have used for decades when making a cash-offer on a home.  All investors use this same formula."

This serves several purposes.  First, it let's them know I'm here to make money.  They already know that, but this puts that in the front of their minds.  It's fair that I make money on this deal.  Second, this is not a negotiation, it's a formula.  I'm not starting with a number to reach an agreeable "middle".  I'm letting them know this is THE number.  Finally, I'm letting them know they won't do better elsewhere.  This is the formula every investor they could potentially talk to uses and it's just THE cash-offer, not MY cash-offer.

"I look at the price I think I can sell the home for when I am done doing all the updating that it needs... in other words, I want to make this home look like 2015, using all the modern and fashionable colors, schemes, trim, fixtures and such."

I never use the word "repair".  If I do, the response from the homeowner is typically, "well everything works just fine", even if the house looks like the Brady Bunch still lives there (or worse).  Stick to updating, its less offensive.  Use the "2015" (or the current year) as it establishes that, while the home may be beautiful, styles change.

"I want it ready to compete with the brand-new homes down the street."

Bringing the home up to date is not a choice.  If its not up to date, KB Homes has another buyer and I don't.

"I think after I do all that, I can get $200,000.00 for the home.... would you agree?"

I want them to agree.... and they usually do.  After all, they know what houses sell for in the neighborhood.  But I am establishing that to get that, the home needs to look like 2015.   Its not the current price of their home.

"I take that number and multiply it by 70% and then subtract out the cost of the updating.  I know that 30% sounds like a wide margin, but I am going to lose 18% on the buy, carry and sale of the property..."

Here's THE formula.  And here is WHY it's THE formula.  Its NOT a low-ball offer.

"...so that allows me to make roughly 12% for my time and money."

It's fair I make money.  But 12% might still sound like a lot for someone who currently is probably making 1.5% in their mutual fund or 401k (or less).  However, this is for my money, but its also for my time.  Now that sounds like a fair and reasonable amount (because it is).

"So $200,000 times 70% is $140,000.  I think its going to take me about $40,000.00 to bring it completely up to date and make it look brand new.  Therefore, the cash-offer for this property is $100,000.00"

I let them know how I arrive at the offer and what the offer is.  But I reiterate that this is THE cash-offer, not MY cash-offer.

Conclude

I don't want to just wait for them to say "yes" or "no".  I've hit them with a big bombshell.  So, at this point, I think its important to let them know you understand this may be less than what they were expecting.  I care about how they feel about it.  So I conclude with, "How do you feel about that price... was that more, less or kind of what you were expecting?"

This allows them to raise objections.  But because you've established that this is the tried and true cash-offer formula, I've opened a dialogue without getting kicked to the curb and called a low-baller!

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