10 Minute Real Estate Lesson 2-What’s in an offer?
Updated: Apr 14, 2020
Spoiler alert-there’s more to an offer than just the price. A LOT more.
When you’re first getting started in real estate investing you typically need all the advantages you can get. If you live in a hot market (like Charlotte, NC), it can be extremely hard to compete with cash buyers who have deep pockets. Good deals may fly off of the shelf before you know they’re even there.
Even if you do have deep pockets, you can still get beat out by someone based on the terms of the offer (which is why we little guys have a shot). The fact is that submitting an offer allows you to play to your strengths and make up for your weaknesses because of the multiple levers you can pull to strengthen your offer.
I'm going to dive into detail on the different parts of an offer to show how you can demonstrate strength and be more attractive to the seller. These are the primary levers I'll discuss:
2. Method of payment/financing
3. Timing (due diligence and closing)
What you do with each one can tell a potential seller a lot about you and how you are as an investor, so if you’re lacking in one area you can try to make up for in another. Let's go!
Have you seen the commercials with Captain Obvious? It should come as no surprise that price is a major factor in determining the strength of an offer. The $$$ in people’s eyes can be blinding.
So how much do you offer? Do you lowball the list price in search of a bargain? Do you offer at list or maybe even above in an attempt to secure the deal? Do you go somewhere in between?
Let me give you a little tip:
The list price doesn't matter!
While list price is often tied to the value, it isn't always. That's why it's so important to perform your analysis properly and identify the true value. For me as a cash flow investor, within a few minutes I can analyze a property and figure out what I need to land at for purchase price in order to arrive at my desired return. It doesn't matter if that's 10% above list price, or 40% below...once you know that number it becomes binary and you can take the emotion out of it.
That said, everyone likes winning and wants to get an even better deal, which is possible if you look for the right signs and listen for the right clues. Here are a few things you can look for that will help you decide what to offer:
1. Time on market: a recently listed property will often have more competition and the seller will likely be more patient, pushing the price up. A property that has been on the market for an extended period of time (which is market dependent) is likely going to have more opportunity to push the price down.
2. Condition: in many cases, the general condition of the home will be factored into the list price in some way based on your market. However, in some cases there may be a situation that a seller just doesn't want to deal with themselves. Especially if the seller is an individual and not an investor, you may be able to get the property at a discount to take a problem off their hands. Perfect segway to...
3. Type of seller: are you buying from an individual or from an investor? While in cases like #2 above an individual may be more inclined to lower the prices due to a hassle/problem, in other cases they may want more because they're emotionally attached to the house. An investor may be more inclined to make a quick sale at a lower cost so they can reinvest their funds, or they may have tenants providing cash flow and they can patiently await their desired price. And speak of the devil, how about those tenants??
4. Inherited tenants: like most things, this can be a huge asset or a huge liability. Do you have proven rent roll with a history of timely payments at a competitive rate? That's probably worth a little more. Are you "purchasing evictions" because you're inheriting subpar tenants you'll have to pay to kick out? You'll probably want to pay a little less to account for the costs.
5. Competition: who is the target market for this property? Are you buying a rundown house that needs to be gutted and rebuilt from the ground up? Typically safe to say you're competing against fellow investors and will need to make a strong offer. Buying a turnkey single family home that would be great for a family with a dog and 2 kids? You're probably competing with families who will emotionally pay more for their dream house, but will mull over 4 competing properties and run at the sign of trouble which allows you an opportunity to be a quick but sure bet for the seller.
You may notice a theme in each of these considerations...they each require thorough analysis to properly identify where the property as well as the owner sit on each spectrum. Get good at identifying how each of these considerations come into play and you'll set yourself up well to make an offer at a price that's right for you.
METHOD OF PAYMENT/FINANCING
How are you going to pay for your purchase? While traditional financing is easy to understand and most people are familiar with it, it may surprise you to know that you can make an offer with "cash" without having it yourself. Let's look at the different options and what they mean...
1. Traditional financing: making an offer with traditional financing is not a bad thing (I've used it on nearly all of my offers and purchases so far), however it tells the seller 2 very distinct things: first, the financing will be conditional upon the bank/lender appraising the house and confirming the value and condition; second, the appraisals and underwriting take time, and therefore you likely will not be closing quickly.
For you, this also means that you need to think about the condition of the property you'll be purchasing (especially if you want a fixer-upper). The property needs to not only appraise for the purchase price, but also needs to be in livable condition. This criteria is even more strict if you're utilizing a VA loan (my appraisal on my primary residence required that a small chip in paint on the front step be fixed before the loan is approved).
Ultimately, traditional financing will be the weaker of the funding options but is not a deal-breaker by any means and can still be strengthened by the offer price and the timing (more on that in the next section). The 10 units I currently own were all purchased with traditional financing.
2. Cash: making a cash offer shows extreme strength to the seller because it tells them the exact opposite of the 2 things that traditional financing tells them: you can move quickly, and you aren't subject to underwriting and appraisal.
Now I can hear what some of you are thinking...
"Cmon Patrick, if I were flush with cash I wouldn't be reading your blog right now"
Stick with me...notice I said you have the cash AVAILABLE, not sitting in your bank account. The key is that you can close QUICKLY. They don't know whether you're sitting on a small fortune or selling your soul to the guy down the street for some cash, and frankly they don't care. All they care about is that you will be giving them a check at closing and they don't have to worry about a bank or an extended closing period.
This cash can come from a number of sources. You may have the cash personally, or you may be partnering with someone who can provide the required cash. You can also utilize 2 types of loans to source your cash-private lenders and hard money lenders. Private lenders can be someone you know who has cash they're willing to lend for agreed upon terms; hard money lenders are generally businesses who offer short term loans for investments based upon the quality of the deal you have, and will generally be more expensive with higher fees.
It's important to note that if you're utilizing a private or hard money lender, you need to have a clear exit strategy. Interest rates will be extremely high and the terms will be short, meaning you need to be able to complete your project and either sell or refinance in order to pay off your loan. However, these are powerful options if the deal is right because you can make an offer with "cash" and move very quickly.
You have two different timing levers you can pull when submitting an offer-the dates of the due diligence (or inspection) period and the closing date. **The conditions of the due diligence period may vary by state-I'm only speaking from experience in North Carolina. Check with a local real estate agent to learn more about your area**
To those unfamiliar, the due diligence period is the time you have available to do your due diligence on the property and confirm that it meets your expectations. This will often include a thorough walkthrough, inspection, appraisal, and gathering any additional information from the sellers (i.e. rent roll, operating statements, etc.). At least in North Carolina, you can back out of the deal at any point until the end of the due diligence period and only be out the due diligence deposit (more on that in the next section) as well as any third parties you paid (i.e. appraiser, inspector), while having your earnest money deposit returned to you.
Sellers see a fast close and a short due diligence period as signs of strength. It shows that you're serious, have your ducks in a row, and at times provides them a quick way out if that's what they're looking for. You want to make sure you have dates that you're comfortable with and are feasible, but also that are as fast as possible.
Your funding source will be your greatest factor when determining how to approach setting your dates. As I mentioned before, this is much easier and faster with cash and is a more extended process with traditional financing; but don't hang your head just yet if you're using traditional financing, you have a few additional tools in your toolbelt:
-pre-approval: work with a bank ahead of time to get pre-approved for a mortgage. This shows the seller that financing will likely not be an issue and that you're qualified, and should speed up the underwriting process.
-paperwork: if you've filled out a mortgage application for pre-approval, you know that they require an inordinate amount of paperwork. Luckily this is predictable and you should have this information readily available. I keep a folder on my desktop that has copies of my drivers license, last 3 years of tax returns, and recent bank and brokerage account statements. I may have to pull the most recent statement, but this allows me to move quickly and help the lender pull the trigger as soon as the contract is signed.
-inspection: identifying a good inspector ahead of time and developing a relationship with them can help you move quickly to get the inspection scheduled as soon as you're under contract. Ask around and see how long it takes them to provide you with the inspection report, and see how fast they can get the inspection done (with and without rush fees). Your realtor should be a great resource to identify reputable inspectors.
-insurance: with financing you'll need insurance in place on the property when you close. Find a couple of good insurance companies you can work with, find out the information they require, and give them a heads up that you're in the market to see how quickly they can move.
-appraisal and underwriting: this is typically what takes the longest. The lead time for both will vary based on the season and on demand, so stay in constant contact with your lender to get a feel for how long each of these are taking on average.
Putting in the effort to line up these tools ahead of time can allow you to comfortably determine how much time you'll need to close, moving up your timetable and making your offer stronger!
Deposits are one part of the process that absolutely varies by state, so if you live outside of North Carolina just make sure you confirm everything in your area!
In North Carolina there are two deposits that you submit within a few days of an accepted offer-a due diligence deposit and an earnest money deposit. The amount of each of these deposits is determined by the selling party and can be negotiated as a part of the deal terms. Like any other part of the process, understanding how a seller will react to your deposits can allow you to strengthen your offer without increasing the price.
Due diligence deposit: this is a non-refundable deposit you provide directly to the seller and can be the ultimate demonstration of how serious you are about an offer. This is paid up front, and when you get to the closing table the deposit is applied to your closing costs. If you have concerns about a property and think it may not pass an inspection or may not appraise, it's smart to keep this low. If you're serious about a property and want to demonstrate strength, you can increase your due diligence deposit and tip things in your favor.
Earnest money deposit: this one sounds a little backwards-this is the deposit that will be refunded to you if you back out of the deal during the due diligence period. It is paid into escrow and returned to you if the deal falls apart before the end of the due diligence period, paid to the seller if it falls apart after the due diligence period ended, or applied to your closing costs if the deal closes. Due to the fact that you can receive the results of the inspection and appraisal and still back out of the deal before this deposit is committed to the seller, you can demonstrate additional strength by increasing this deposit at little risk to you.
While it may be daunting to write a check you may never get back (although it's unlikely you'll lose the earnest money deposit), it's important to think about both ways it may play out. If you've done your proper analysis as an investor, you should only be submitting an offer on something that will be profitable to you. It may provide a few hundred dollars per month in cash flow on a rental, or it may provide a check for tens of thousands of dollars on a flip. For that return, is putting $500-$1,000 on the line for a well researched and analyzed deal too much? If so, it may be smart to spend some time building your reserves until you're comfortable doing so.
In a competitive market where you're up against someone who can offer more money or a faster close, showing how serious you are by increasing the deposit is just one more option that you can use to swing things in your favor!
If you're reading this there's a good chance you're like me...just a normal guy who isn't overflowing with cash but wants to forge his path as an investor. While we may not be the biggest fish in the pond, when armed with the right knowledge there are a lot of things we can do to compete with them!
Have you pulled any of these levers and been successful? Are there any others that I didn't mention that were incredibly helpful to you? If so, please reach out to me or comment! And if you found this helpful, or think it may help someone you know, please share! I want to help as many people as possible apply the lessons I've learned.
If you have any comments or questions, or there's any way I can help you, please don't hesitate to reach out to me at firstname.lastname@example.org and follow me on Instagram at @investdgp!