The Art of Haggling: Negotiating a Price and Terms

Making an Offer They Can Refuse (But Will Consider)

Preparing an offer (also known as a purchase agreement) on a property is like deciding how much to raise the bet in a hand of poker when you’re holding a royal flush. Raise too much, and everyone folds. Raise too little, and someone may see your raise and end the betting long before you suck enough chips into the pot for a big payout. You want the betting to go on long enough so you can get more of what you want.

When you’re preparing an offer, your goal isn’t necessarily to have your first offer accepted. If it is, you may be paying more for the property than you should. Your goal is to offer just enough to persuade the homeowner to counter your offer and to show you’re serious. In other words, you want to make an offer they can refuse but will consider and counter.

If a seller accepts your opening bid, it doesn’t necessarily mean that your bid was too high. Don’t get the heebie-jeebies and start second-guessing your decision. You did your homework, you made an offer on a property that you know you can profit from, and you got lucky. The homeowner accepted your bid. Now it’s time to move forward. Delay can lead to downfall.

The following sections highlight the most important factors to consider in preparing your offer, including price, earnest money, conditional clauses, and other enticements.

All offers and counteroffers must be in writing. With real estate transactions, the written word rules. Verbal agreements are worthless. The saying in the industry is “Buyers are liars, and sellers are worse.” Get everything in writing. Your real estate agent can supply you with the form you need to officially present your offer.

Calculating a price

Before you make an offer on a property, you already know the maximum amount you can pay for it, based on how much you think you can sell it for; estimated costs for buying, renovating, holding, and selling the property; and your desired profit. (Chapter 12 shows you how to calculate your maximum purchase price.) But your maximum price isn’t necessarily the price you want to offer. When settling on a price to offer, the following three strategies are most effective:

Leave a little haggle room. Offer 3 to 5 percent below the price you’re willing to pay to allow some room to negotiate. You don’t want to offer a price so low that the owner dismisses the offer outright and refuses to sell — or, even worse, goes with another investor’s offer — but you don’t want to price yourself out of a profit. This strategy works well in most cases.
Make a firm offer. Make your best offer, let the seller know that this is your best offer, and stick to it. I’ve seen firm buyers remain firm and have the seller reject the initial offer only to come back three weeks later, highly motivated to sell. If you can remain firm, this strategy may be the best for you. Some buyers stick to this strategy in every case. Others do it only when they know they can profit from the property even if their best offer is accepted and they’re pretty sure that it’s the best offer the buyer is likely to receive.
Make a low-ball offer. A good time to make a low-ball offer is when you’re already working on a project and don’t really need another property. If you get the house for a steal, great. If you miss out, you really haven’t lost anything.

Consider including a one-page letter that explains how you arrived at the price you’re offering. For example, you may point out that comparable homes in better condition are selling for more, but that this house needs a new roof, which would cost about $8,000; a remodeled kitchen, which would run about $10,000; and new carpeting, which would cost about $3,000. You may actually be able to get the work done for a lot less by doing some of the labor yourself, but it’s okay to quote what the seller would have to pay to have the work done professionally. Don’t jack up your estimates — the seller may have estimates of her own, and you don’t want to look like a swindler. Chances are you’re telling the seller what she already knows. Your letter simply shows that you’re no dummy — you’ve done your homework.

Proving you’re earnest: Money talks

The old saying that “money talks” is especially relevant when you’re pitching an offer on a house. Every offer should include earnest money that demonstrates how serious you are about purchasing the property. A $5,000 earnest money deposit speaks louder than a $500 deposit.

I can’t offer you any hard and fast rules on what to offer in the way of earnest money. That depends on several factors, including how much cash you have on hand, how badly you want the property, and how much you’re offering as a purchase price. In general, earnest money in the range of $1,000 to $5,000 is sufficient. The more you put down upfront, the stronger your position at the bargaining table.

As long as you deposit the earnest money with the title company (see Chapter 4 for more about title companies) or another reputable and insured real estate professional, your deposit is safe. In most cases, the seller’s broker holds the earnest money. With REO sales (see Chapter 8), the bank may require that the listing broker or title company hold the deposit. Either way, the money is safe unless you default on the purchase agreement. When the deal closes, the money is credited back to you. If the deal doesn’t close, you get the money back, assuming, of course, you lived up to your end of the bargain — you were diligent in seeking financing, you showed up for the scheduled closing, and you had a good reason to back out of the deal.

Another way to show that you’re serious about the deal is to provide proof of your financing along with your offer. Proof of financing may consist of a preapproval letter from your lender. If you’re offering cash and have a good chunk of it sitting in a bank account, you may include a copy of your bank statement with your account numbers blacked out. A signed and notarized statement from a private lender can also function as proof of financing. Head to Chapter 5 for details on securing financing for a flip.

Dangling additional enticements

Although the purchase price is the high-profile part of any offer, a real estate transaction isn’t always all about money. Sellers have other needs. They may need some extra time to move, a new place to move to, some ready cash, or maybe even a good used car to get to work. By knowing the seller’s needs and her motivation for selling, you can often sweeten the pot by addressing her most pressing needs. Check out the following sections for tips on providing additional enticements to the seller.

Helping the seller move on

Instead of approaching a negotiation as a contest, consider it a collaboration between you and the seller with the goal of meeting everyone’s needs. You need to acquire a property at a price below market value. Find out what the seller needs most:

If the seller needs more time to move, consider giving him 30 days of free rent and then start charging him if he stays any longer. Taking a loss of a few hundred dollars to gain thousands later is often a wise choice. In the meantime, you can start lining up your contractors and planning renovations (see Chapter 14 to get started).
Help the seller find a new place to live if she doesn’t know where to go. As you become more involved in real estate, you establish connections with other owners and landlords and can often refer sellers to other people who can assist them.
Refer the seller to a probate attorney if he needs legal assistance.
Advance the seller some money so she can secure alternative housing, or assist her with getting a Section 8 voucher if she qualifies for subsidized housing. You can find out more about public housing vouchers and track down your local public housing agency through the Department of Housing and Urban Development (HUD) at www.hud.gov.
Call around to car dealers if the seller needs affordable transportation.

If the seller isn’t ready to sell right away, don’t get pushy. You may lose the house for good. Consider purchasing the property on contract (granting you the option to purchase the property at a later time), as I explain in Chapter 3. That takes the heat off the seller and provides you with a future project.

Do whatever you can — if it’s aboveboard and reasonable — to help sellers get on with their lives, but don’t cross the line. Helping distressed sellers get on with their lives versus plying them with favors so you can steal their property may seem like a fine line, but it’s a line between right and wrong, between legal and illegal.

Laying down cash

In real estate, cash is king. Think of it like a deck of playing cards. Cash is king. Fifty percent down is a queen. Thirty percent down is a jack. Twenty percent down is a ten. Ten percent down is a nine. Five percent down is an eight. And zero percent down is a joker. To have the winning offer, you want to lay down a king.

Offers with large down payments in cash always have an edge over other offers because they have less risk of falling through at the last minute due to the buyer’s failure to obtain loan approval.

You may be wondering — if cash is king, what’s an ace? Con artists consider an ace to be an offer of cash back at closing, but that’s actually a joker, and if you get caught, that joker can lead to jail time. Working out a deal in which the seller agrees to sell you the property for more than it’s worth so you can get a big fat loan and split the proceeds with the seller is a form of fraud.

Protecting your posterior with weasel clauses

Weasel clauses (more officially known as conditional clauses) are legal phrases in the purchase offer that enable you to weasel out of the offer if something goes wrong. Although they’re designed to help buyers back out of a deal when they can’t get their financing approved or in the event that the home inspection uncovers a serious problem with the property, they’re often used as escape clauses when a prospective buyer gets cold feet or finds a better deal. Make sure that your offer contains the following weasel clauses:

Financing must be approved. If you’re taking out a loan to pay for the property, make the purchase conditional upon your financing being approved. Buying property you can’t pay for is a sure way to end up in foreclosure. If you have cash on hand to pay for the property, don’t worry about this clause. (See Chapter 5 for more about financing.)
Sale is subject to closing on another property. If you’re counting on the proceeds from the sale of another property to finance the purchase of this property, stipulate that your offer is conditional upon the closing of the transaction on the other property. If you add this condition, include a copy of the offer you have on the other property so the seller knows you have an offer pending on that other property.
Property must pass inspection. To ensure that you don’t get stuck with a termite-infested house or a house that has foundation problems, make your offer conditional upon the home passing inspection. Not only does this clause provide a safety net, but it also buys you time to obtain estimates on repairs and renovations. See the section “Inspecting the house from the ground up,” later in this chapter, for more about inspections.
Property must have a clear title. A clear title ensures that the property has no liens against it and that the person selling the property actually owns it. Never submit an offer without this condition. (Chapter 4 has the scoop on hiring a title company to do a title search for you.)
Property must appraise at the sale price or higher. To ensure that the property is worth what you’re offering, make your offer conditional upon the appraisal. See the section “Ordering an appraisal,” later in this chapter, for details on the appraisal process. (This shouldn’t be an issue, because if you’ve done your homework you should know that the property is worth more than what you’re paying for it.)
Buyer’s attorney must approve contract. A clause that gives your attorney ten business days to inspect and approve the contract provides you with additional time to seek a qualified second opinion. (See Chapter 4 for details on finding an attorney.)

Note: When I represent the seller, I hate these clauses. I try to get rid of these to help protect my seller’s transactions. When I represent buyers, I use them.

Conditional clauses may protect you, but too many of them can sink the deal. Many purchase agreements have built-in conditional clauses required by local governing agencies or associations. Familiarize yourself with the purchase agreement used in your area so you’re not adding redundant clauses that raise red flags. Your agent can provide you with a copy of the purchase agreement used in your area.

Tending to the Details: Inspections, Appraisals, and Walk-Throughs

Just because the seller accepted your offer doesn’t mean that you have a done deal. Now’s the time to test those conditional clauses I tell you about earlier in this chapter. You need to schedule a home inspection, have the property appraised, and do one final walk-through before closing, as I discuss in the following sections.

Inspecting the house from the ground up

Immediately after the seller accepts your offer, schedule a home inspection. (Chapter 4 explains how to find and select a home inspector.) The inspection ensures that the house doesn’t have any hidden surprises, such as foundation problems, a faulty electrical system, or substandard plumbing. In the following sections, I explain different areas of concern to examine and show you how to put the inspection results to good use.

Although some experts recommend staying out of the inspector’s way during the inspection and waiting for the written report, I strongly recommend that you schedule the inspection for a time when you can be present, preferably during daylight hours, so you have a clear view of the external features of the house. You should be there to hear specifically what the inspector has to say during the inspection. Take notes or carry a recorder for later reference, and pack a digital camera so you can take a picture of any defects the inspector points out and reference them later.

Examining areas of concern

If the inspector raises any doubts about a big-ticket item, such as the condition of the roof or furnace, or if she recommends additional tests or inspections, schedule follow-up inspections. For example, if the furnace is old, call in a heating and air-conditioning contractor to inspect it more thoroughly. (Chapter 4 has information on finding contractors.) The cost of repairs to any of these items varies depending on the nature of the problem and material and labor costs in your area. Areas of concern often include the following:

Foundation: The entire house rests on the foundation. If it shows signs of water damage or serious settling, have it professionally inspected. Fixing the problem may be a simple matter of repairing the gutters to direct more water away from the foundation (inexpensive), or it may involve jacking up the house and pouring a new foundation (extremely expensive).
Electrical system: If the home inspector points out any concerns about the electrical system, have a licensed electrician inspect it. An electrician can tell you whether the system is up to code and, if it’s not, provide an estimate on the cost to bring it up to code.
Plumbing and septic: A home inspector typically checks the plumbing to ensure that the water pressure is sufficient, nothing is leaking, and drains are freely flowing. If the plumbing appears to be substandard, have a licensed plumber inspect it. If the septic system is more than ten years old, have that inspected as well.
Aging big-ticket items, including furnace, air conditioning, and roof: If something is old but working, don’t assume it’s okay. Have a licensed contractor check it out. Even if a furnace is heating the house, it may be leaking carbon monoxide or have other problems that the inspector doesn’t notice.
Attic and insulation: Make sure that the inspector checks the attic. Does it have sufficient insulation? Does the insulation contain asbestos? Does the underside of the roof show any signs of damage or leaking?
Grading: Does the ground slope down away from the house as it should? Poor grading can funnel water right into the home’s foundation and is costly to fix.
Lead-based paint: In some homes built before 1978 and many homes built before 1960, lead-based paint may be present. You can pick up a test kit at your local hardware store to test for lead. In some cases, correcting this problem can be cost-prohibitive — because you must disclose the presence of lead-based paint on your seller’s disclosure, it can drive a lot of potential buyers away.
Asbestos: Commonly used to insulate furnaces and water pipes, asbestos is a health hazard that’s costly to deal with. If it turns up in a home inspection, obtain a couple of estimates on having it removed and then calculate that into your rehab costs.
Radon: Radon is a cancer-causing gas that can be a problem in some areas of the country; it often requires that the foundation be sealed and vented or even completely replaced, which can cost thousands of dollars. Your local environmental protection agency can tell you whether radon is a problem in your area.
Toxic mold: If the home shows any signs of moisture damage or mold stains, have it tested for toxic mold and determine the cost of eliminating the mold and its cause. The presence of toxic mold (often called black mold, even though it’s not always black) is enough to kill a deal — fixing the problem can cost as much as the purchase price of the house. If you suspect mold to be a problem, call a certified mold remediation specialist for additional testing and any necessary treatment.
Lead pipes or lead in water: Some homes built before 1940 have lead pipes or copper pipes joined with lead solder. If lead is a concern, call your local water company to have the water tested. The cheap fix is to install a water filter for the drinking water. More-expensive fixes call for replacing the pipes or installing a whole-house water filtration system.

The home inspector is sort of like your family doctor. She can give you a quick examination to tell whether you’re generally healthy or not, but if you have any specific complaints that she’s uncertain about, she refers you to a specialist. The home inspector can tell whether everything is functional, but if you or the inspector has a specific concern, consult a specialist.

If you’re buying a property that the seller winterized, the gas, water, and electricity may be shut off, preventing an inspector from doing a thorough job. In this case, request that all utilities be turned on for the inspection.

Moving forward with the inspection results

You can use the home inspection results to your advantage in the following ways:

If the home inspection turns up serious, expensive problems that the seller refuses to fix, you can back out of the deal.
If the home inspection identifies required repairs, you can lower your offer to accommodate the cost of those repairs both in terms of time and money or demand that the seller pay for those repairs.
You can ignore the little stuff and further endear yourself to the seller by avoiding the urge to nitpick.

If the inspection uncovers some issues that tempt you to submit a new counteroffer, realize that a counteroffer essentially places the property back on the market. I’ve seen many investors lose out on a good deal by being too picky.

Ordering an appraisal

If you’re borrowing money from a bank or other lending institution, you don’t have to worry about ordering an appraisal. The lender does it for you and adds the cost to the closing costs. Actually, the lender does the appraisal not to protect you but to protect the lender’s investment. Even so, you should request a copy of the appraisal. The appraisal can either confirm or refute your belief that you’re not overpaying for the property. Submit your request in writing; normally, the form you need is in the package you receive at closing.

When you’re purchasing the property with your own cash or with money from a private lender, consider ordering an appraisal to ensure that the property is worth what you think it’s worth (an as-is appraisal) or what it will be worth after repairs and renovations (an as-repaired appraisal). In most cases, your agent’s advice is sufficient, assuming he has a thorough knowledge of the market, but if you have any doubts, a professional appraisal can put them to rest. I give you tips on finding an appraiser in Chapter 4.

If the appraisal shows that the house is worth way more than you offered, pop the cork on that bottle of champagne and start celebrating. If the appraisal comes back showing that you offered too much for the house, you then have several options:

Buy the property anyway. An appraisal is an opinion, so don’t ignore it entirely, but take into account that the appraisal could be 5 percent to 10 percent lower or higher than a buyer is likely to pay.
Assuming you made your offer conditional on the property appraising for a certain amount of money, and assuming the property appraises for less than that, back away from your original offer and submit a new, lower offer. (This action places the property back on the market, so it’s a little risky — you could lose out on the deal.)
Ask the seller to throw in an added enticement to get you to go through with the offer.

Taking one final walk-through

The day before closing — or better yet, the day of the closing — walk through the house one last time to make sure that it’s in the same condition or better than when you placed your offer. Until you close on the deal, the seller owns the house, and anything that happens to it is his responsibility. If the hot-water tank bursts the day before closing, you’re entitled to a new hot-water tank at the seller’s expense. If the wind picks up and the roof blows off, that’s on the seller’s tab.

Pack your digital camera and a notepad and document anything that looks out of the ordinary — any new problems that arose after the inspection.

Closing the Deal

When you attend a closing, the title company’s closing agent hands out a bunch of forms and contracts and tells you to read everything, make sure that you understand it, and sign and initial the documents as directed. Except for a handful of control freaks, nobody reads through all those forms, but you really should. People can hide all sorts of zingers in a legally binding contract.

To be safe, you or your attorney should read, understand, and agree to everything stated on a document before you sign it. To keep closings from taking much more than an hour, I recommend that you ask the title company for the closing packet in advance and read everything or have your attorney or your agent look at the paperwork before the scheduled time. (You may have only 24 hours before closing to review the paperwork.) Write up a list of questions along with any errors you find and have them addressed before closing. If you wait until closing, some serious delays are likely to occur.

Don’t sign anything unless you have read it and understand it! Pay close attention to the following items:

Your name: Make sure that the documents include your legal name and not your nickname.
Your Social Security number: These documents are official records and are likely to show up on your credit report, so make sure that your Social Security number is correct.
Information on the 1003: If you’re taking out a loan to purchase the property, you receive a 1003 (commonly referred to as a ten-oh-three) at closing. This is your loan application, and it includes your name, Social Security number, annual salary, and other details about your finances. The loan officer presents this information to the mortgage company. Giving false information is mortgage fraud, so make sure that all the information is correct before you sign the form. You can’t leave this one up to your attorney to verify; read it yourself and correct any errors before you sign.
Mortgage and interest rate: If you’re taking out a loan to purchase the property, make sure that the mortgage amount and interest rate recorded on the form is the same as what the lender or loan officer quoted you. Have any necessary corrections made before you sign the form.

If you’re a flipper and you’re taking out a loan, make sure that it has no early-payment or prepayment penalty. Nothing is more shocking than reselling the house and finding out at the closing that the $200,000 loan you took out to purchase the house has an extra $6,000 added to it as a 3 percent penalty for paying off the loan in fewer than three years. Double-check for any prepayment penalties before closing.