IC Elesson: How to Know When You’re Ready to Make Deals
(this article continues from last week, where I described the problem with objectively being ready to make an offer, vs. ‘feeling’ ready, and how there are forces in the world that try to convince you that you aren’t ready when you actually are).
Here’s when you know you’re ready, whether you “feel” ready or not:
- When you can correctly assess the after-repaired value of most properties of the type on which you plan to make offers. I say “most properties”, because there are some that are so unusual that even an appraiser can only guess at value, for the simple reason that they’re weird. Most properties that fit into this category—your octagonal houses, your poured concrete houses, your 19-century farmhouse in the middle of a 1950s subdivision—aren’t great targets for investment anyway. As long as you can compare a 1200 square foot frame 2-story to a 1396 square foot 2-story and come up with a value that’s within 5-10% of ARV, you’re ready to go.
- When you can make a thorough-ish inspection of the visible components of a property and recognize when something probably needs to be repaired, replaced, or left alone, and can put a reasonable-ish number on the cost of said repairs or replacements. I say “ish” because, while all of our formulae for evaluating properties require a number be plugged into the “repairs” box, missing something or underestimating a repair cost isn’t fatal as long as you can also check off item #3. What’s MORE fatal is having no idea what ANYTHING should look like or cost, and greatly over-estimating your costs, so that all your offers are too low and none ever get accepted.
- When you understand what other due diligence is appropriate for the strategy and property in question, and how to do, or have done for you, that due diligence. This, again, is pretty basic Real Estate 101 type stuff: how do you check out that the ‘deal’ is what you think it is? Pretty much EVERY property, or note, you’d ever buy should be the subject of a professional title search, for instance. But there’s other due diligence that you’ll need to know to do that’s more strategy-dependent. For instance, when buying an income property, you’d typically want to review the leases, rent rolls, and expenses before making a final decision to close. If you’re getting bank financing to buy, an appraisal would be part of the bank’s due diligence. In the case of most real estate, you’d want to check with the building and health departments to see if there are orders that need to be dealt with. If you can make a list of the due diligence you’ll need to complete to assure yourself that your particular deal is a good one, you can check this box.
- When you have a basic understanding of the contract clauses that you need to protect you should you do #1 or 2 incorrectly, and to account for things you find in #3. Writing an offer is rarely the final stage of a negotiation. In fact, in most contracts, and ACCEPTED offer is not the final stage. Because, contingencies. Those are the contract clauses that allow you to get out of the contract should further due diligence prove to you that the offer itself, or the offer price or terms, were a mistake.
For every piece of due diligence that’s important to the deal (see #3), there should be a corresponding contingency (“If x doesn’t turn out like I thought, then I don’t have to close and don’t lose any earnest money). For every single thing that must be true in order for you to close (the bank approves your loan, the zoning department approves your change from residential to business zoning) there should be a corresponding contingency. When you understand what those are and can get them into your purchase agreement, you’re good.
- When you have a clear understanding of your exit strategy. “Clear understanding” doesn’t mean “I took the course”, or “I can give an elevator speech about what I do”. It means that you really ‘get’ what the strategy is all about. If you can answer these questions, you understand your exit strategy. If not, go back to the book before trying to make offers:
- WHO is my customer for this strategy? i.e. an investor who can pay cash; a first-time homebuyer; a blue-collar tenant etc.
- WHAT about any deal that I do makes it attractive to my customer? Is it that the buyer will make a profit from it? How much profit, and is that cash or cash flow? Or is it that the property is completely 100% renovated and ready to move into and in a desirable location? Or is it that Section 8 will approve it? It depends on your ideal customer, of course, but it’s an important question to be able to answer.
- WHAT KIND of property, or features of a property, are attractive to my customer? The point of these first 3 questions is, of course, to make sure you’re not making offers on the wrong properties in the wrong areas at the wrong prices to satisfy whoever it is that will ultimately buy and/or live in the property
- What is the standard ‘formula’ that people use when making offers with the goal of exercising this exit strategy? And just as importantly, WHY is this the standard formula? If you understand WHY rehabbers pay no more than 70% of the after-repaired value less repair costs, it will keep you from making serious mistakes when you make offers
- WHEN and in WHAT FORM does my profit come? Is it one time, in cash, and within 30 days, as in wholesaling? Or is it in the form of monthly cash flow, as in renting?
- HOW LONG is the realistic expected lifespan of this deal? One of the biggest mistakes investors make in negotiating TERMS on deals is that they agree to timeframes that are unrealistic for the actual lifespan of the deal. For instance, they agree to a 1-year balloon in an owner-held mortgage on a property they plan to lease/option. If you REALLY understand the realities of lease/optioning, you understand that 2-3 years is the minimum hold time and that if something goes wrong with your first tenant-buyer, you’ll need 5 years to sell.
- What are the exact steps to IMPLEMENTING the exit strategy? What happens after the closing? What should the timeline be?
- In what ways can this exit strategy FAIL? In other words, what can go wrong, or what can you DO wrong, that will cause it to lose money? What are the fixes to these problems?
- What are ALL the contracts needed to implement this exit strategy? Different strategies require largely the same purchase agreements, but drastically different contracts (contracting agreements, leases, options, land contracts, assignments) to EXIT from them. If you can’t enumerate what these are, what they do, and where they reside in your files, get that together before you make an offer.
- When you know how to source the types of deals that your strategy calls for. Another way to say this is, “Who has the kinds of deals I’m looking for, and how do I contact that person or entities? This means very different resources depending on the type of asset your exit strategy depends on, and it often changes with the market cycle. For instance, the answer for a wholesaler looking for cheap ugly properties in a down market might be, “Banks and listed properties” while in an up cycle it might be “Motivated sellers who don’t have their distressed properties listed”. For buyers of defaulted notes, the answer will more or less always be “Bulk buyers of defaulted notes, small banks, and individuals who’ve purchased notes that have subsequently defaulted”. Whatever the best sources of your particular deal, you’d better understand them and how to access them, or you’ll spin your wheels either looking for people to whom to make offers, or making offer to the wrong people.
- When you understand some VERY basic negotiation rules. This is one that I considered leaving off the list, because it is NOT necessary to be an expert negotiator to make an offer. But in certain strategies, there are negotiation tactics that will commonly be used against you that it helps to know how to counter. For instance, sellers of turnkey rentals, notes, and investment opportunities often use a scarcity tactic (“I have 19 other people interested in this, you’d better pull the trigger if you want it”) that you need to counter with a refusal to be a motivated buyer. Agents will often claim to “be in multiple offers”, and ask for your “highest and best by 5:00”, tweaking your competitive spirit and tempting you to bid against yourself (you may already have the higher offer, and there may not be another offer). Letters of intent are common and expected in apartments and commercial properties; a seller or agent getting an LOI instead of a purchase agreement from you will tend to be amused, or confused, rather than take it seriously. Knowing what objections you’re likely to get from seller (and how to overcome them) is something you’ll learn by making offers, but you’ll be less taken aback by them if you learn what they are ahead of time.
- When you can describe sort of financing, if any, your exit strategy calls for YOU to get, and where you’ll get it. There are all sorts of financing available, and not all are really applicable to all exit strategies. The right financing for your exit strategy will combine the right term (don’t agree to a balloon sooner than the worst-case end date of your deal), the right payments (which will be a function of the interest rate, amount borrowed, and term), and the other terms that compliment your resources. Hard money loans are easy to get, but if you plan to hold the property for rental, a 12% interest rate and 13-month balloon aren’t the right financing unless you have a way of ‘taking out’ the loan with a more appropriate one later. Hard money isn’t even your solution for rehabbing properties unless you have 10% of the cost of the deal in cash; most hard money lenders won’t let you get into a deal with no money down. You need to be able to state exactly what terms you need and NAME where you’ll get those terms (xyz bank, uncle moneybags, the right seller, whatever) before you can make an offer that has a chance of closing.
- When you know who else you’ll need to get the deal completed. By name. You are not ready to make a wholesale deal offer if you don’t know the name and phone number of the wholesale-friendly title company or attorney who will close the deal. You’re not ready to close a rehab until you know the name and number of the roofer, the plumber, the window guy, and every other contractor you’re going to call to get bids. You’re not ready to buy a note until you have a servicer in mind. Every strategy involves other players. If you don’t know generally who they are and specifically who they are, you’re not ready.
- When you know how to get answers to questions to which you won’t know the answer. You need to know—really KNOW—the things above in order to make safe, smart offers. But you don’t have to know everything about everything. That’s a thought that was either implanted by the education industry, which has a vested interested in making sure you spend as much money as possible getting ready to get ready, period. Or it’s a thought that your (mostly unfounded) fears of making a mistake have lodged in your head as a way of forcing you to procrastinate, so you’ll never have to face anything scary.
Either way, it’s not real, because you know what makes up for any gaps in the details of your knowledge? Having access to someone who DOES know, preferably from years of experience rather than from more book learning. Their knowledge can fill in for your lack of knowledge about the minor stuff, as long as you have a real grasp on the things I’ve outlined above. Think about it for minute and you’ll realize it’s true: as long as you have the basics down and have the safety net of an experienced person’s advice for the other stuff, you’re probably not going to make a financially or personally disastrous error. That’s why you joined the Inner Circle, right?
So that’s it: my comprehensive list of what you need to know to start making offers, an act that will get you a LOT further down the path to profit than sitting in more classes. Making offers gives you so many things: a new set of questions to ask. New confidence. And, ultimately, profit.
What about all those other things you’ve been told you “need” to be safe, or to be successful? Like an asset protection plan, an IRA, the right software, a bookkeeping system, and so on and so on? Yes, you’ll eventually want and need these things, but they’re mostly pretty easy to buy and/or set up. So how about FIRST proving to yourself that you’re going to do what it takes to NEED an LLC, or a QuickBooks set up, or whatever, by doing some deals? Your path will be a lot straighter, less overwhelming, more profitable, and less expensive if you do.