Wednesday, August 27, 2008

A Little "Yellow Padding" Goes A Long Way!

OK, pull out your ugly, yellow note pad! This cheap thing is what separates the sheep from the goats in negotiations.

What do we do with a seller who wants to believe his house is worth say $325,000, but is really only worth $285,000? Do we walk away, and say, "Next!"? Or do we lead the seller back to reality, in an attempt to get a bargain? Well, if you're patient and answered, "Lead the seller back to reality to get a bargain", then you'd be the one making the big bucks!

In the Fall of 2003 I sat at the kitchen table of Denise, a lady who was in pre-foreclosure. She was NOT upside down, but had lost her job, could not afford her payments, and wanted out --- for a good price.

Well, of course not being in the business of paying retail for anything, I empathized with her plight, but politely reminded Denise that, "The only way I could help her was to steal her blind, equity-strip the crap out of her house, and pray that she didn't sue me later for buying her house for half of what it was worth". In the nicest way possible, of course.

Nah. Just kidding. I didn't say that!

Actually I simply went through a checklist of "Yellow Pad" questions that started with what she thought her house was worth. She told me. I said "Fine", after suggesting that I wanted to analyze the rest of the numbers with her in order to find a reasonable sale price that we could both agree on (How does anyone disagree with that, I ask.).

Let me show you exactly what I did for Denise.

BTW, my approach is used by professional negotiators worldwide, and isn't a proprietary strategy, BUT it's amazing how many professional negotiators don't use this simple tool. Also, this negotiating approach is successfully used to buy anything for a decent price --- without insulting the sellers, or worse.

This is a powerful tool, and we should be careful not to use this to cheat sellers, or take advantage of their ignorance. Used legitimately, this is a fair and honest way to analyze the numbers for any purchase, and may be used to talk yourself OUT OF BUYING. I've come to the conclusion not to buy property using this analysis tool, when the seller failed to cooperate with the discussion, or the numbers didn't make sense after all. It's also the most fantastic way to show the seller, using his own numbers, why he is unrealistic in his expectations on a certain sale price.


So, here was Denise's scenario --- analyzing the numbers with my over-size calculator, my ugly, yellow note pad and bold blue Sharpie.


Jay: Denise, what do you believe your house is worth. (She lies and gives me a huge, over-retail figure).

Denise: I think my house is worth
$550,000.

Jay: Ok, fine. (Writing that figure at the top of the yellow pad) Would you be willing to take five percent off that price in order to sell more quickly. (She wants to know what 5% is equivalent to so I calculate it to be -$27,500).


Denise: Yes, that would be OK.

Jay: So that would be a -$27,500
discount, correct. (listing that amount with a minus sign in front of it with my bold blue Sharpie)

Denise: Yes.

Jay: In a conventional sale the real estate commissions runs between 5 and 7 percent. For our purposes we'll use 6%, ok. That comes to -$33,000. (We use the full retail price as our working number, not the discounted price. I list that figure in bold black numbers with a minus sign in front).


Denise: OK,
$33,000.

Jay: Now we have conventional closing costs of about 3% of the purchase price. That comes to -$16,500, ok. (I list that number with a minus sign in bold fashion.)

Denise: OK,
-$16,500

Jay: Now, we have about $26,000 in repairs; new paint in and out, new carpet, roof repair, tree removed, pool resurfaced, and driveway replaced (we previously discussed and estimated repairs immediately before we started the yellow pad analysis), ok (This is stated as a fact, not a question).

Denise: Yes, -$26,000, that's about right, but maybe less.


Jay: Yes, it could be less, but we only use competent, licensed professionals, because we're not in the contracting business, you understand, ok. (Again, not a question, but a statement).


Denise: Yes, I understand.


Jay: Now, if you remember a few minutes ago, we showed you that there was 23 months of inventory on the market for used houses. So, as a result, it will take 23 months to get a house like yours sold at full retail only if the agent is competent, correct (a statement, not a question).


Denise: Yes, 23 months I think. It's taking a long time to sell these days.


Jay: You showed me that your monthly payments on the house are
$2,844 per month plus taxes, insurance and the HOA of $750 for a total of $3,594 per month, correct.

Denise: Yes. -$3,594.


Jay: Well, if you continue making payments on this house for the next 23 months (as "carrying costs"), it's going to cost you an extra
-$82,662 to hold things together until a buyer comes along according to the market data, correct. (I list that number under the rest of the numbers with a minus sign, of course).

Denise: Yes, but -$82,662 is quite a bit, and if I discount the price, it might sell it faster, right?


Jay: Yes, maybe, and for discussion, let's agree that
it takes half the time to sell with our -$27,500 discount. That's still -$41,331 dollars.

Denise: But I'm going to have to pay to live somewhere, so I don't see that figure really meaning anything to me.


Jay: Yes, but you won't be living here by then. (She will lose the home, and will have to find someplace MUCH cheaper anyway, maybe not $3,594 a month cheaper, but we don't go into that unknown. She might have to live with relatives, or even in a shelter if she can't find a job. Who knows?).


Denise: Yes, that's probably true.


Jay: Now you said you owed approximately -$450,000 on your first, correct.


Denise: Yes.


Jay: Well, let's 'add up' our numbers here (we don't say "subtract") and see what we come up with.

$550,000 Current Value (Actual Value was $520,000)

< $27,500> Less 5% Discount for "quicker sale"
< $33,000> Less Realtor's Commission of 6%
< $16,500> Less 3% Closing Costs
< $26,000> Less Repairs
< $41,331> Less 11.5 months of PITI paid until sold
<$450,000> Less Mortgage Balance
----------------------------------------
<-$44,331> Seller pays this amount just to sell home conventionally.

Jay: Not a good solution is it.

Denise: No, I can't afford that.


Now Denise sees her numbers used, and realizes that she used an inflated value of about $30,000 to throw me off at the beginning of my analysis. Whoops, even with her over-stated retail value, I still showed that she was upside down. Who knew?!

I offered Denise $1,500 to move out. Promised to get her house sold and refinanced asap. She gave me the title. I did as I promised, and re-sold the house immediately to a credit challenged buyer, offering no credit check, for $572,900, with -$30,000 down, at 7% interest for 30 years, or $3,611 a month P.I. I got the buyer refinanced in twenty months.

Using the "Yellow Pad" I negotiated a gross equity spread of $122,900, and a payment spread over 20 months of $15,340 (my buyer's principal/interest payment to me of
$3,611, minus my $2,844 on the original mortgage --- $767 dollars per month cash flow).

So that's $122,900 plus $15,340 for a grand total of $138,240 in gross profits --- over 20 months, all while using the yellow pad analysis to redefine the seller's expectations and perception of value.

BTW, Denise went and bought a brand new, cheaper house with zero down from a builder, got her credit improved by me, and lives happily ever after.

What was the actual retail discount I achieved? Well, $520,000 was the true retail, less the first mortgage of $450,000, which comes to a 13.5% discount. That's not much! But when we sell to a credit challenged buyer for a premium of about 10% more, we've effectively achieved a 23.5 discount! This all without having to go pull our pants down to have the bank do a financial anal exam on us, require us to put down 20% in order to secure new purchase money loan! It's a beautiful thing.

Caveat: Sub2 does work in a falling market! However, we may have to offer longer term financing, focus on lower LTV prospects, and/or become much more aggressive in our final offers. Today, I just tell the seller, I have to make $50,000 on this deal, and discount that much at the end of the analysis, and say, "Or I can't help you." This means there actually has to be that extra fifty thousand somewhere. Meanwhile, sellers know I'm an investor, and seller's expect something like this, and they call me anyway. I advertise myself as an investor, so there ya' go.

///


3 comments:

Burke said...

Jay,

Very interesting entry. I enjoyed reading it and have a few questions for you.

1. What do you use to show the months of inventory to the seller and how do you explain that info to them?

2. Do you develop your own repair estimate on the spot?

Thanks!

Jay said...

Burke,

Thank you for the compliments!

RE: Question 1:
There are several things we can do to demonstrate/illustrate/prove the current inventory on the market:

1. Ask a local broker for the information. It's good to keep a broker or two as friends.
2. Find and download articles that mention the local market conditions/inventory.
3. Do your own estimate. Find out how many homes are for sale right now in a certain geographic area (the one you're marketing in mostly). Then determine the number of transactions that have closed in the last 30 days. Then divide the current number of homes for sale by the number of solds, and voila, you have the number of months of inventory. This is about as accurate as it gets.

RE: Question 2:
Yes, I "develop" my own repair estimate on the spot, if I have to. However, it's really a good negotiating tool to have the seller cough up the numbers, if at all possible --- even if they're a tad under what you think it will cost. You can always weigh in with your estimate after the seller reveals his opinion.

I find that I often underestimate the costs, and the sellers often overestimate the costs. I love "depending" on the seller's numbers in these instances.

Meantime, when I go through the house, I just casually ask if the seller has "gotten an estimate to repair the roof, or not."

Or I might put it this way; "Do you have any quotes on what it will cost to fix "X?" Either way, I haven't insulted them for not fixing anything, or allowed the damage, or "notice" the damage in an insulting fashion.

Most sellers will tell me what they know, if they're not given time to think of a lie.

The anxious, unsophisticated sellers will barf up everything they know.

Meantime, if the seller is unrealistic with their estimates for repairs, or say they've got a "friend" who can replace the entire roof for a dollar and a half "out the door". Then we're going to have a harder time bringing them over to reality. It's pointless to argue.

Another negotiating approach is to simply state with confidence what "X" will cost to fix and then wait for the seller's reaction. If the seller balks, then either the seller actually knows better, or maybe we're in front of the wrong seller.

I like working with the sellers that agree with me because they think I won't buy their house otherwise. :)

BTW, it's a bad thing to get into a negotiation over costs. We just need to matter-of-factly "add" the numbers during our yellow pad analysis. If the seller says they can get the roof fixed for a buck and a half we just agree. Later we'll think of things to offset that "stupid" estimate, and get to the price we're happy with.

Does this answer your questions?

Great post.

Jay

Burke said...

It answers it very well. Thanks!

Do you need a shadow for a few weeks? :-)