CHAPTER 7: Finding Property that is Prime for Flipping
Once you familiarize yourself with the generalized process of house flipping, the players involved in it, and the documents you will be frequently signing, it is time to start looking for property. Locating property prime for investing requires a combination of instinct and science. First, you will need to find an in.
Finding an “In”
As we reviewed in previous sections, having connections in the world of real estate is not only an advantage, it is critical to your success. It is important to build yourself a network of other investors and real estate professionals. First, introduce yourself as a buyer in the market and find an agent. Tell the agent that you intend to flip the house. A good agent will be able to put you in touch with others who may benefit from the connection. After some time, you will become familiar with other investors in the area as well. Although these people will sometimes be your competition, it is important to view them as potential helpers as well. Sometimes you will encounter a property or opportunity that is not right for your investment style, but may be perfect for a fellow investor with whom you are familiar. That same investor may eventually find himself in a similar situation with you in mind sometime in the future. View your competition as friendly, not hostile.
Auctions are another great way to find potential flipping property while familiarizing yourself with the local investment players and their hierarchy. After attending a few auctions, you will know who the power players are and have an idea of what it will take to survive in your local investment scene. You will also know what it will take to secure properties to flip in your area and how far your dollar will go. Do not become so involved in your observations, though, that you forget to mingle. Striking up a casual conversation in a setting as informal as an auction is a great way to begin forming your network. It can also be a good way to get to now some of the lawyers and accountants in your area who specialize in real estate.
Good old-fashioned newspaper classifieds can also be a great way to get your foot in the door. Look for classified ads that use taglines such as “We Buy Ugly Houses” or “Cash Now for Your Homes.” Chances are, these are investors like you who are fishing for houses. Call the numbers and ask questions. Introduce yourself. You may initially be greeted with a bit of repressed hostility, but you just might make a friend who can provide you with some invaluable insight. When you feel the time is right, go fishing yourself by running a few ads of your own. You will get some curious inquiries, but you also just may convince that one homeowner who is desperate to unload a potential gem to sell to you at the right price.
Join a professional organization and attend a convention. Conventions and seminars are a great way to begin networking. Not only can you meet others in the business, but also you often get the opportunity to hear some of the most successful members of the community speak on what helped them succeed as well as what did not. The National Association of Real Estate Investors (NAREI), for instance, is an organization that offers the assistance of mentors, as well as educational opportunities and workshops to its members. Making friends within an organization of like-minded professionals is not only beneficial, but it can be profitable.
Advertise. Let people know that you are looking for properties in which to invest, in order to lead potential sellers to you. Place an advertisement in the classified section of your local periodical stating that you are an investor looking to buy property. Have business cards printed up and capitalize on every opportunity to pass them out or display them. Begin taking contact information from local For Sale signs in the area and directly contacting the selling agent. Speak with him or her about your goals. Most agents are motivated by potential clients and good ones are great informational resources.
Sponsor a local youth athletic team in a community recreation league and advertise in tournament books. This sounds rather trite, but it actually has far-reaching subliminal impact and is usually a somewhat inexpensive marketing ploy, typically less than $200. People may not necessarily realize that they are registering your business name every time they see it screen-printed across the jerseys of the team you sponsor, but when the time comes for them to utilize your services, they will often recall the name of the business that sponsored “the team with the purple shirts.” In a way, this type of advertising works very much in the same way as paraphernalia for political campaigning, but research has proven that when voters know nothing about the candidates vying for a specific political office, they will cast their vote based on name recognition. Simply put, people choose what they know. Similarly, community members may not know that much about real estate, but if they spend twelve weekends in the spring and fall looking at your name splashed across the shirts of local youth and in the pages of tournament books as they try to figure out whether Junior’s team is going to make it to the semifinals, they will know your name when the need arises. This greatly increases the chance of their calling you versus a random business name they pull out of the yellow pages.
Finding your first property is typically the most difficult. However, once you find yourself a way in and establish your team of professionals and contractors, your success is completely in your hands. You are limited only by the restrictions you place upon yourself.
Identifying Neighborhoods of Opportunity
Although when you first begin to consider a career in real estate flipping, a specific neighborhood may immediately pop into your mind, choosing an area in which to focus is not always as obvious as it seems. Chances are, many of the hot neighborhoods in your area that are currently experiencing a renaissance of some sort are probably already overflowing with investors. In such cases, it may pay off more in the long run for you to do some research in order to determine what area may become the next new “it” neighborhood, and focus your efforts there. Investment properties are probably going to be costly in an area that is popular, and even retail buyers, who would otherwise prefer a home that is in move-in condition, may be willing to compete for a fixer upper for the opportunity to live in a neighborhood that they might not otherwise be able to afford.
In choosing a neighborhood to focus your flipping efforts, every beginning investor is faced with the problem of whether to buy the best house in the worst neighborhood or the worst house in the best neighborhood. Either could be the correct answer, depending on the situation. It is true that the more undesirable the neighborhood is, the smaller your potential buyers market will be. Quite simply, fewer people are willing to take risks for even the best house in a neighborhood notorious for crime, poor schools, or mostly rundown homes. However, if that neighborhood happens to be going through somewhat of renaissance, people may be more willing to take the chance in exchange for the opportunity to get in on the ground floor of a boom that promises to explode the value of the property within a few years. Therefore, the best bet for locating a neighborhood ideal for flipping homes is to locate an older neighborhood in town that is on the verge of rebirth. You can determine this, not merely by following home sales and property notices in the area, but just by following the development trends. If you begin to notice a fair amount of new retail or commercial businesses appearing in the area, that may be a good sign that the economy of that neighborhood is on the rise. Pay attention to local news features or stories that announce plans for new shopping centers, restaurants, or entertainment complexes.
If you do not already have a subscription to the local newspaper, get one. Checking the classified section should become a daily routine. In addition to checking the advertisements of homes for sale, you should also read the public notices. Public notices will include bankruptcy, foreclosure, and auction notices.
Take a drive. Drive around potential neighborhoods and pay attention to the general upkeep of homes in the area. Pay attention to the cars parked in the driveways or on the streets. Are they newer or older? If you are driving around during a business day, does there seem to be an unusual number of cars parked at their homes? Evaluate the neighborhood for its proximity to places of convenience such as gas stations or grocery stores. Search for other selling points for the area such as mature trees, wooded lots, etc. Make a mental note of the type of people you see out and about. Does the neighborhood appear to consist primarily of younger families, empty nesters, or young professionals? This will be your market demographic when its time for you to sell. As you peruse prospective neighborhoods, make a mental note if there seems to be an unusually high number of For Sale signs in the neighborhood. This could be a red flag for some sort of underlying issue in the neighborhood and may warrant further investigation.
Once you narrow your neighborhood search down to a couple prospective locales, start regularly checking the MLS ads for those areas. The Multiple Listing Service is a database of all properties for sale in a geographic region that is specifically targeted to real estate professionals. The MLS contains such information as square footage, a breakdown of room sizes, property tax information, annual homeowner’s fees (if applicable), school district, and condition of the property. The MLS database will help you create a comparative foundation for what houses are selling for in the area and how condition is affecting selling costs. It can also help you establish a base for how long houses are generally staying on the market before being sold, which is important when each month your property goes unsold is costing you another mortgage payment. One aspect of MLS worth mentioning, however, is that in some cities, the MLS database is freely accessible to anyone with an internet connection while in other cities some of the information is restricted to real estate professionals. If you live in a city that does the latter, you will need to have your agent provide you with regular information from the MLS.
It is worth addressing the fact that, although some investors do not restrict their business to a single neighborhood or even city, it is not recommended that you begin your career on a national or international level. Conducting multiple and continuous real estate transactions across state lines requires a certain level of skill, experience, and expertise that requires a seasoned professional with a great staff and an even better attorney, because you are no longer dealing exclusively with the laws of one state, but many. Expanding to an international scale is something that should be considered very carefully. Although you will see many advertisements promising cheap real estate in foreign countries, it is important to remember that it’s just as important to be familiar with the area in which you wish to buy in a another country as it is in your own. This means that, before you even begin to consider purchasing property in a foreign land, you will probably need to take multiple scouting trips, which, depending on the country in which you are considering investing, can become rather expensive very quickly. Once you determine that you would like to own property in that country, you will also need to familiarize yourself with the real estate laws of that country. This often involves a lot of bureaucratic red tape that is best and most efficiently dealt with by hiring an attorney licensed to practice in that country. Finally, once you own a home or piece of land in a foreign country, before you even begin any type of work on it, you will need to understand the local regulations for renovations in that region as well as the customs and processes for employing workers. In short, it can become a rather complicated bureaucratic process that is best handled by third party professionals whom you hire, which will require quite a bit of pocket change. The good news is that, just as in your own country, once you find your “in,” you are in. However, the cautionary advice being offered here is to ensure that you have plenty of time and funds before you even begin to think nationally or globally. In short, it is usually best to start at home and expand outward.
Scouting
When you are out driving neighborhoods, do not only look for houses with For Sale signs in front of them. Look for properties that show signs of being vacant or are unusually unkempt for the area. Look for overgrown grass and landscaping that has not been maintained, notices taped to doors, or boarded windows. Sometimes these properties are prime targets for flipping opportunities. These homes could be involved in estate escrow as the result of a death, going through the foreclosure process, occupied by the very elderly with no relatives nearby, or owned by someone who has encountered financial difficulties and may be motivated to sell. If you find a property that interests you, watch it regularly. If its status does not change or it continues to decline, begin checking city or county records to check the status of the home. Interview neighbors to see if they can give you any further information. This process is called scouting.
Professional scouts are actually considered by many to be a third type of flipper. In this book, however, they are being included in the section on scouting, because I do not consider them flippers in the true sense of the term. A scout is never actually involved in any part of the home buying process. Rather, they are a sort of housing headhunters. Scouts will search for and follow leads for prime flipping properties. They will then sell their information to investors who do buy houses. Some flippers use scouting to get their foot in the door before graduating to full fledged investing and flipping. If you don’t have the credit or cash flow to jump directly into flipping, beginning as a scout may be a good way to get into the business and circulate your name while improving your credit and saving money.
How does scouting work? It can actually be as simple or as complicated as the individual acting as a scout chooses to make it. In its simplest form, a scout can simply be the errand person for an investor—someone he or she sends out to search for available properties in a specific neighborhood. This type of scouting may simply involve searching for homes that may be on the open market, but not necessarily advertised in the most lucrative manner, such as homes for which the owners are acting as the agents. Another type of scout acts on his or her own terms and then proactively seeks investors who may benefit from the information gathered. These individuals will locate properties that are in disrepair and appear to be unoccupied and are not currently listed on the market, and they will visit city and county records offices to locate the owners. They may then contact those owners directly to see if they might be motivated sellers. If they are, the scout then has a potentially viable flip for an investor that is not available to the mass market, since the owner is not actively seeking to sell the property.
One word of caution to would-be professional scouts, however, is to remember that a good deal of your integrity will rest on your ability to deliver. Therefore, it is important that you can deliver what you promise. In order to do this, you must be very good at reading people. If an owner agrees that he or she may be interested in selling simply from pressure to do so, that owner may not turn out to be such an avid negotiator. Although the investor to whom you shopped the deal may become frustrated with the owner, he will be equally frustrated with you, because you brought this deal to the table. If you plan to earn a decent income as a scout, then it is important for you to form partnerships with investors, which you do by carrying through on your promised product.
Expect to earn more of a part-time income as a scout when you are first starting out. Since scouts merely sell information and have virtually no involvement in the real estate transactions themselves, they naturally earn the least amount of any of the parties involved. A few hundred dollars for a good lead is typically considered a fair price. One benefit of being a scout, however, is that you are technically a service provider and not a real estate professional, and that means you escape many of the pitfalls of the tricky real estate laws when tax season rolls around.
Evaluating Property Potential
When determining whether a property is a good investment for flipping, it is important to carefully weigh the pros with the cons and to be honest with yourself about the time and budget that will be required to bring the house to retail quality. Aesthetics can usually be repaired in a short time and with a minimal budget. Often times, it is amazing what a simple coat of paint will do. However, some properties require considerably more extensive work. Problems such as termites, foundation cracks or flaws, old roofs, bad plumbing, or outdated electrical wiring can quickly eat your budget and destroy your timeline. If a property will require any of these types of work, it is critical to weigh the costs of having such a large project completed with the other improvements that will also be needed against the potential profit. If the property will require work that will cost more than what you stand to earn, obviously, it is not a good investment. If you are unsure how to determine if a house has these problems, hire an inspector. The fee could be invaluable to you later. If you are feeling the pressure to make a decision immediately, make your offer contingent upon an inspection. This will buy you some time to have the property checked out thoroughly.
Likewise, do not be scared away by sheer ugliness. Even a fair amount of cosmetic cleanup can be done cheaply in contrast to the tens of thousands of dollars it can cost to repair a foundation or rewire an entire house. Often, when appearance is the only aspect of a house that requires improvement, there will be more sweat and elbow grease involved than money.
It is important when viewing a property to keep an eye out for issues that may prove to be costly to fix. Although some of them are most easily found by a professional home inspector, some have telltale signs that are detectable to virtually anyone who is monitoring for them. Take paper and pen with you to take notes as you tour the property.
• Note the materials out of which the house has been constructed and weigh it against the typical climate of the area. For instance, in areas near the ocean, the naturally high salt content in the air tends to have an adverse affect on wood. Therefore, it is a good idea to be particularly cautious of wood-sided properties in such a region and to inspect thoroughly the condition of the wood. If it has rained recently, make note of water drainage. If there are multiple puddles in the yard, it could be a sign that there is not proper irrigation for the property. This could have an adverse affect on the conditions of the house.
• When you enter the house, how does it smell? A damp or moldy smell could be indicative of poor or no insulation, leakage, mildew, or mold. Although these types of problems are often most obvious in basements, they can sometimes be found throughout the house, particularly in high moisture climates. If the property utilizes a septic system, be on the alert for a gassy or sewage smell. There may be issues with the septic system.
• Are there hot and cold spots in the house? While there is an ever-so slight chance that it may mean that you have ghostly visitors, it is most likely a sign that there is either poor circulation or problems with the heating and cooling systems. A simple and inexpensive fix such a cleaning the vents could also be the solution, but it is still important to make note of these types of problems and to determine their cause.
• How abundant are electric outlets? In older homes, this is crucial. In today’s gadget and electronically oriented society, one outlet in each room is not practical. If there are too few outlets, you are probably going to need to bring an electrician in to install more. While this in and of itself should not make or break your decision to purchase a piece of property, it could also be your first indication that the wiring is outdated and may need replacing, which is a costly venture and something that should definitely be carefully considered before you decide to buy. Also, ask the owners how often they find themselves changing light bulbs. If it is frequently, do some more fishing to find out if it could possibly be attributable to an electrical problem or if they are just in the habit of leaving lights on throughout the house.
• In the bathrooms and kitchen, check around the toilet and sinks for evidence of leakage. Water stains or wet spots may be a sign that there are issues with the plumbing. Check faucets and exposed pipes for evidence of rust as well. This could mean corrosion, which may be a sign of larger plumbing issues. Another good sign of plumbing or leakage issues are water spots on ceilings. Be sure to look up as well as around when you are touring a piece of property.
• Check walls for cracks and plaster breaks. Simple cracks may be somewhat easy and inexpensive to fix, but it is important to determine first that they are not a sign of larger structural issues. Particularly in older houses in which the walls are made of plaster, large gaping holes are generally not reparable and typically need to be reconstructed, which could get very expensive.
• In the basement and outside, check for issues with the foundation. If the house is built on a crawl space, check for problems around the outside of the house. It is also a good idea to consider geological makeup of your area in relation to the type of foundation as well. For instance, in particularly sandy conditions, full basements are not generally a good idea. Even if there are not currently any problems, the tendency of the ground to shift could eventually lead to issues later. In such a climate, a crawl space or cement slab is probably the most desirable foundation.
If you are not accustomed to checking houses for potential red flags, it is a good idea to bring a professional inspector with you, if not to the first walk through, then to any subsequent ones. Typically, a house inspector can be hired for $200-$300, but it can save you up to ten times that in unexpected repairs.
If you can, create a list concerning other features of the house that may not directly figure into your decision to purchase the house, but will eventually be useful information when you are creating your renovation budget.
• On the list, leave space to record information regarding the age of major appliances, carpet, hot water tanks, air conditioning units, and the roof. If the owner is unable to tell you the last time the roof was replaced, for example, that is probably a good indication that it may be time to replace the roof.
• Also, make sure you record the capacity of the hot water tank and keep this in mind as you tour the house. Is it sufficient for the number of sinks, showers, and bathtubs in the house?
• If the house has a fireplace, ask the seller if it is functional and, if so, ask when it was last cleaned.
• Make a note of how many outlets, cable, and telephone jacks are in each room. Also, record any built-in features, such as shelving.
• Count the number of closets in the house. Is the storage space in relation to the size of the home adequate, or is that a feature you may consider expanding or adding when you renovate?
• Note which rooms in the house have built-in light fixtures, as well as what type of natural lighting each receives. Is it sufficient or does lighting need to be added? If so, it is a good idea to remember that this is a cost that can add up quickly and, although it is not necessary, it is very desirable to many potential buyers and something you may want to consider.
• Note the countertop materials in bathrooms and kitchens. Like lighting, this is another feature that many potential buyers scrutinize.
One of the unfortunate aspects of investing is that timing is, more often than not, key, and you are forced to make split second decisions after having only had the opportunity to tour a house once. Many retail buyers often tour a house at least twice before making the final decision to buy. However, in the investment world, competition can sometimes be fierce and in the time it takes to arrange a second tour of a property, it can be sold and the closing paperwork well on the way to being signed. This means that sometimes you are going to have to make decisions based on some rather ambiguous information and without the benefit of all of the details on your list being neat and tidily arranged. As you become more experienced in purchasing real estate, you will learn what is important to look for and how to sum up a property rather quickly. In the interim, it is highly recommended that you arrange to take a house inspector with you when you a tour a home.
Sometimes you may not even have the benefit of being able to tour a property before buying. Many bank-owned properties are like this. When this happens, do what you can to gather as much information as you can about the condition of the home. Ask former owners and bank officials if they can provide this information to you. Although you may not be able to tour the property since such types of property are often sold “As Is,” relevant information about the state of disrepair is often made available to anyone who requests it. However, a disclosure is often included excluding the bank (or whoever owns the house) from liability concerning the accuracy of the information.
Once you have evaluated the condition of the property and decide that it would be a good investment, it is time to establish a few facts in order to determine how realistically within reach the home actually is.
1. The first and most logical piece of information you will want to know, if you do not already, is why the owner wants to sell. Is he moving? Are there financial issues? Some answers that are not necessarily deal breakers, but red flags to consider, are comments regarding neighbors or the neighborhood, particularly strict homeowner or historical codes, dissatisfaction with the performance of the school system, and high property taxes. These could all be signs of deeper trouble and, although they may not turn out to be deterrents from purchasing the property, they do warrant some investigation, because they will ultimately affect either your construction and renovation efforts or the decision of potential buyers to purchase the home once you have completed the project. Sometimes this information is established prior to your touring the property. In these instances, it is possible to do any necessary research prior to seeing the property, so that you may view it with a clear and realistic picture of the situation.
2. The second thing you will want to establish is how soon the owner hopes to sell. If they give you an answer that indicates they hoped to sell yesterday, that is a good sign. Chances are, you are dealing with a motivated seller. However, if the response to this question is closer to an answer that indicates that the owner doesn’t know or has not really given the issue much thought, this could be an indication that the seller is currently only toying with the idea of selling the property. When this is the answer you receive, follow it up by establishing what the owner hopes to achieve by selling. Does he need money? Has he purchased another home?
3. Finally, you will want to establish how flexible or motivated the seller is. If he seems bent on the asking price, you are going to have a tough time when you enter into negotiations. On the other hand, if the property is in fairly decent shape and the asking price is fair, this is not really much of an obstacle at all, only a formality.
You may occasionally find more than one property in which you would like to invest and will be faced with comparing them in order to choose. Assuming you are working within a target neighborhood, we will not discuss the issue of location, because all potential properties will, theoretically, be equal in that respect. Therefore, the next determinant for you to consider is size. However, when considering square footage, it is important to consider the potential square footage of a piece of property with the current useable space. For instance, if one of the potential properties is a three bedroom house with rather small rooms and a poor layout and the other property is a roomy two bedroom with enough useable space to convert it to three, then it may be the better investment to purchase the two bedroom home and convert it to a three bedroom, rather than simply purchasing the three bedroom home, if you determine that the cost of the conversion is within your budget and will add enough value to justify the alterations. That said, it usually is understood in the world of real estate that if the opportunity presents itself for you to add a bedroom and/or a bathroom, you should do it. A three bedroom home will usually sell for a higher price than a two bedroom home, and a property with two bathrooms will inevitably fetch a higher price than a house with only one.
Assuming both properties are equivalent in size, next consider condition and special features. Perhaps the previous owners of one property recently redid the kitchen, which means that the amount of work and, more importantly, money that you will need to spend on renovating the kitchen will be minimal, whereas, the kitchen in the other house will need to be gutted and reconstructed. When condition is not always such an obvious factor, do a side-by-side comparison of features. Does one house have bigger closets? A working fireplace? Jacuzzi tubs? These are just few of the things that may give one property an edge over another.
When evaluating the actual price and profit potential of a property, there are a few things to consider other than the purchase, renovation, and selling prices. Essentially, any expense you incur in obtaining, refurbishing, and selling the house is an expense which deducts from your profit. This means that things such as underwriting fees, closing costs, holding costs, and maintenance expenses should be figured into your overall equation. Many new investors fail to consider these things and realize only too late that their profit will be considerably smaller than they originally planned.
Negotiating the Deal
Once you have found the property you want, you have to secure it. If you are the only potential buyer, this will not be as complicated of a process as it would otherwise be if you had competition, but there are still specific steps that must be taken.
• Do your math. Have the figures worked out in your head. Do not just pull a figure out of the air. Before you make an offer, know the typical price range of homes in the retail market in your area, and estimate how much it is going to cost you to bring the house to that condition. Add the purchasing price of the house to the renovation costs and subtract them from the selling price, and that is your profit potential. Use that as a starting point. If you would like a larger profit, bid low and negotiate your way to a happy medium. It is also important to know your bidding ceiling before you start. Know the minimum profit you expect to generate from the sale of the property, and figure the maximum amount you can pay in order to realize realistically that profit.
• The inspection list you made while touring the house can be used as a great negotiating tool. If a homeowner is unwilling to come down on the asking price, then use your list to have some of the potential expenses you expected to incur after you bought the property resolved. If the hot water heater needs replacing, for instance, counter the seller’s offer with a contingency that you will agree to a higher price if they will replace the hot water heater.
• Leave room for negotiation, and never make a closed offer. Always leave yourself room to wheel and deal. When figuring up your numbers, it is usually better to establish a range rather than set numbers. This gives you room to negotiate the best deal and helps the seller feel as though he has options. In the end, it is the best way to achieve a win-win feeling for everyone.
• Know your facts. Do not limit your homework to home prices in the area. If you can, find out what position the current owner of the house is in. Why is he selling? Does he have to sell? Is there some sort of financial burden weighing on him that he cannot overcome? Is he in danger of foreclosure? All of these things could have an impact on how you will want to negotiate the deal. Someone who is more or less just tinkering with the idea of selling or who has no reason not to be in a hurry to sell is going to be less willing to give away ground in negotiations than someone who needs money very quickly and is motivated to sell because of it.
• Establish relationships. It goes without saying that you should already be friendly with your agent. In this particular situation, your agent as your friend becomes particularly valuable because he can be your voice from a business perspective. If your agent and you have taken the time to get to know each other, your agent will be able to plead more effectively on your behalf to the seller’s agent. It is also important to establish a relationship with the seller, if possible. Make yourself stand out among your competition. Treat the seller almost as client instead of an obstacle standing between you and an object of desire.
• Do not do third party negotiating. Simply put, go straight to the source. Find out who will have the final say on the sale of the property, and do everything you can to gain direct exposure to this person. This is often most efficiently accomplished by simply asking the question, “When do you plan to make a decision?” At this point, many sellers will often either state that they must first discuss the matter with their wife, husband, partner, co-owner, etc. If they do not specifically identify the other person(s) involved, they will typically still use the pronoun “we.” When they do, simply ask them to identify who else is involved in the “we” to which they are referring. This will help you establish the seller’s hierarchy structure and where the individual with whom you are currently speaking falls within it. If your initial contact is hesitant about giving any answers concerning negotiations, chances are that he or she is just an acting agent and has little or no say in the final decision. Upon establishing this, save your negotiation efforts for the time being, because they will be wasted at this stage of the game.
• Do not allow yourself to form a sentimental attachment to a property. This is the most common mistake of all potential buyers. Forming an attachment to a particular house will cloud your judgment and may lead to a financial mess, because you will be more likely to be persuaded to stray from your budget or pay more for a piece of property than it is actually worth or, more importantly, more than you will ever be able to get back out of it.
• Do not make negotiations personal. This is a business transaction, and you are a business owner. A seller is attempting to get the highest possible price for his or her property, and you are attempting to attain it for the lowest possible price. If both parties are able to remain reasonable and rational, then chances are that you will be able to work out something. However, if either becomes emotional or unreasonable, the best thing may be to walk away from the table. Sometimes, this may mean that the seller will move on to the next potential buyer, who may be swayed into a bad deal more easily than you. If that happens, do not waste time in should-haves and could-haves. Instead, think of the buyer as someone who saved you from a bad deal, and move on to the next property. There are also times when the seller will eventually realize he or she has been unreasonable. If this happens, your professionalism may ultimately pay off for you in the form of the deal you were hoping to get.
Overall, if you give the impression of being a human being attempting find a win-win situation for everyone involved instead of a money hungry investor who will stop at nothing to secure the property, you will be a lot more successful in the end. Remember, unless the seller is in dire financial straits with the bank knocking on the front door while you are knocking on the back, the seller ultimately decides whose offer he accepts. The trick is often times not in the numbers themselves, but in the way in which you present yourself as a person.
Some investors will play a considerably more dangerous game of helping somewhat cunning and stubborn sellers feel as though they are walking away from the table with the better end of the deal. However, I do not particularly recommend this type of negotiation. Although it can work out in the end and be somewhat profitable, you can also end up being burned. My primary argument against this type of bargaining is that, if the seller is willing to deceive in order to sell, then it is worth questioning what other aspects this seller is willing to hide or cover up during the sale. You could be fooled about the status of the property, the condition, or anything in between. Although there are exceptions, my experience has been that conducting an honest business transaction is a two-way street and requires equal integrity from both parties.
Auction, Bank Owned, Foreclosure, and Owner Selling Properties
Acquiring certain properties requires a special and often times specific approach because of the conditions under which they are being sold. Potential foreclosures, bank owned, and auction properties are such types of real estate. In these situations, there are often special processes for acquiring these properties. Potential foreclosures are the most sensitive, because they involve wheeling and dealing directly with homeowners who are often in desperate financial situations. These types of people are often convinced that everyone is out to get them, and the key to negotiating deals with these homeowners is not in the details of the house itself but in convincing them that you are not out to take advantage of them like their creditors and the bank. Bank-owned properties are often obtained directly from the bank, which requires following a detailed procedure established by the bank. The trick to acquiring these types of properties is not in the procedure itself, but in finding an “in” that will allow you to establish yourself with the bank. Auction properties usually involve some type of pre-registration process in order for you to be able to bid on potential properties.
Houses are often auctioned for one of two reasons: they are bank or government-owned, or they are part of a deceased’s estate. Bank-owned homes are often foreclosures for which the previous owner stopped making payments, so the bank went through the process of legally exercising their lien on the property. In order to recoup some or all of their lost funds, they will place the house up for auction. A government-seized home, on the other hand, is property the government has seized in connection with some sort of federal crime for which the penalty allows the government to take possession of the offender’s property, such as tax evasion or drug trafficking. The government will auction the house in order to be relieved of the burden of maintaining it. Most of the time, auctions are straightforward business. A minimum opening bid is established, and interested buyers will bid against each other until the person willing to pay the most for it is the only remaining bidder. However, some government auctions do have pre-established guidelines detailing who can participate, and in some cases, there is a pre-approval process. It is important to check the stipulations of government auctions before attempting to bid.
Many times, when the owner of the property is the lender, a minimum bid price will be established prior to the auction. This is usually either fair market value of the house or the amount owed on the loan note. In these situations, an auction property is not always a good buy or a bargain. Assuming these types of properties are always a good deal is somewhat akin to assuming that it is always cheaper to purchase food at the local wholesale club. Sometimes, what seems like a real bargain actually translates into a lot of wasted cash and food. In the real estate market, an auction bargain can similarly turn into an expensive waste of money and effort.
Although auction properties are usually not available to tour prior to the sale and are typically sold unseen and “as is,” it is important to do some homework in these situations. You should determine the typical selling price of properties in the area to determine if your best buy is from the local wholesale club, or if you would be better off sticking to a good sale in the retail market. Check MLS listings and sale notices to determine what selling prices have been in the neighborhood in which the auction property is located. Compare the conditions of these homes with what you know of the condition of the auction property. Then do your research to determine the general property values of the neighborhood for the past several years. Has it gone up, down, remained steady? This will help you determine a minimum, median, and maximum price range for property in the area. Using this range, you can balance those amounts against the estimated cost of renovations and repairs you anticipate will be required in order to figure out if the lender owned property is a good buy.
Sometimes a homeowner who is in danger of foreclosure will sell in a last ditch effort to avoid the foreclosure. These can be both ideal and somewhat awkward situations. The upside is that you can often get these types of properties at a very good price, since the owner is in somewhat of a desperate situation and attempting to avoid an even more desperate one. However, you may encounter a homeowner who is convinced the whole world is against him as a result of his financial difficulties and is rather hostile toward potential buyers. In these situations, the trick is to convince the homeowner that you would like to help him out in assuming ownership of the house and that you are not an agent of the bank who is attempting to scam him like they did. Present yourself to these types of people as someone who is providing a service. Regardless of whether you initially meet with the open arms of relief or by warring homeowners prepared to do battle with anyone who tries to take their house from them, you will want to confirm just how far into the foreclosure process the home is before you buy. If formal foreclosure has not yet started, then it is safe to proceed. Often times, the foreclosure process can often times be stopped at any point by bringing the payments on the house current. Nevertheless, some lenders have stipulations that create a sort of point of no return. In short, make sure the house can still be legally bought and sold before you enter into an agreement with the current owner.
When a property is particularly tempting and the homeowner is unwilling to negotiate, sometimes it is possible to purchase the loan for a pending foreclosure directly from the lender. Since this process is specific to individual lenders, it is impossible to discuss exact terms here. However, you can generally expect to pay anywhere from 70%-100% of the amount owed on the loan. Some lenders also have a blanket policy in which, by procedure, they give the homeowner a specific amount of time to respond to their foreclosure notice before selling the loan note. Therefore, even though a lender may be interested in selling the loan, you may have to play a waiting game.
In recent years, buying and selling mortgages that are in danger of being foreclosed has become a lucrative, albeit risky, market of its own. Be prepared for competition. The lender wants to recoup what is owed, but is also a business, so if several investors are vying for the same mortgage, note that it is not necessarily going to be first come, first served. It may be an under-the-table auction game in which the highest bidder takes the prize.
If you acquire a mortgage loan that is pending foreclosure, it will be your responsibility to carry out the foreclosure and assume possession of the property. If you do not, and the borrower remains in arrears, it is no longer the lender’s money that is being defaulted; it is yours. This means that your income to debt ratio is adversely affected and, if you do not take action, this property could significantly diminish your buying power as well as your ability to purchase other properties, until it is resolved.
Sometimes, homeowners will market their homes themselves simply because they do not want to pay commission fees to a real estate agent. Dealing directly with an owner can be good, because before you even begin negotiations, all of the middlemen have been eliminated. Everything that takes place about the deal will be strictly between the owner and yourself. Unfortunately, this can sometimes be a disadvantage too. Whereas an agent might be able to advise him that it s a good idea to accept your offer contingent upon the inclusion of the kitchen appliances, an owner often has no experience selling homes; therefore, he has difficulty seeing beyond his own, which will make him much less willing to negotiate, particularly concerning any aspects of the house for which he has developed an emotional attachment. Real estate professionals keep the deal an objective business transaction.
The fact that a homeowner is unwilling to pay the fees to a licensed agent could indicate one of two things about him. First, it could indicate that if he was unwilling to pay a 4%-7% fee to an agent, he may not be willing to give much ground in any negotiations. Second, it could indicate that because he is saving 4%-7% of the sale price on real estate fees, he is more willing to compromise a little in the deal. Either way, you will probably be able to get a feel for which one he is after speaking with him for only a short amount of time. If the seller turns out to be the former, sometimes the best approach is to make an offer that you are sure will be one of the higher offers he receives, yet leaves you enough room to generate a profit from the sale of the property. Tell him you would appreciate a call if he changes his mind, and then go home and wait. Once he realizes that his best offer was yours, he will call you, because this type of buyer is motivated by money. Simply put, the highest bid is going to be the one he accepts. If the homeowner is the latter, then use his flexibility to get what you can, but still avoid taking complete advantage of him. Remember, always be professional. The deal in which you take advantage of someone may come back around to haunt you in the form of a black spot on your reputation, which could be considerably more costly to repair than any flip you will ever do.
Making an Offer
In a more traditional home buying situation, you will make an offer for a property in which you are interested. When making an offer, as in negotiating a deal, it is important to try to understand what it is that the seller wants out of the deal and how that relates to what you need. Determine the ideal and then decide for what you will settle. Then, to the best of your ability, determine your competition. Does there seem to be many interested parties, or did the seller almost emulate desperation? Of course, you will have a little bit more room to make demands in your offers if there are fewer prospective competitors. However, the trick is to present an offer that will not scare the seller away altogether without first presenting a counteroffer, yet still includes your wish list. This can be achieved by presenting an offer that is the right combination of money, assurance, and speed.
While it is true that sometimes the higher the down payment you present the better the chances that the seller will accept your offer, there are other factors that may flip the tables in your favor. If you are ready to move, then offer to close quickly. Some sellers really just want to move on, and if they are forced to wait six more weeks or even two months, that means two more mortgage payments. Therefore, they may be willing to accept an offer of a lower down payment with a speedier closing instead.
Almost all sellers nowadays ask for a letter of financing approval or pre-approval before they will even consider an offer. The reason for this is quite simple. A tremendous amount of time and energy is wasted in the negotiations and acceptance of an offer only to have the buyer’s financing fall through. Therefore, it is a good idea to be prepared. Once you have your financing in order or a lender is willing to grant you a mortgage loan, go ahead and obtain a letter of pre-approval that you can present with your offer.
When touring a potential property, always verify what is and what is not included with the house. Never assume. If you ask about something, such as an appliance, that is not initially included but you would like it to be, ask for it in the offer. Many times sellers can be persuaded to include items that they did not initially intend to sell with the house for the right offer. If they do not wish to negotiate the sale of something in the house, they will disclose it in the counteroffer.
Always be sure to leave yourself an out in the form of a contingency to your offer. A contingency allows you to back out of an accepted offer to buy without penalty or further obligation. Make sure these contingencies secure your earnest money. As long as there is a contingency tied to your earnest money, then it is still refundable. However, if you do not include any conditions in your offer that address your earnest money and then you back out of an offer based on one of your conditions, even though perfectly fair and legal, it may cost you the earnest money you included up front.