Negotiating Deals That Earn Big Profits

Negotiating Deals That Earn Big Profits

Real Profits Don’t Come from Playing Games

Negotiating is sometimes nothing more than game playing. It’s done by appliance dealers, horse traders, and real estate agents. It’s most often like a ritual and sometimes it’s not very effective.

Here’s how it typically works. Let’s say you ask your real estate agent the price for a particular property and he tells you the seller wants $100,000. You ask, “What do you think he’ll take?” Your agent says, “Let’s offer $85,000 and see how he responds.” The seller counters with $95,000, to which you quickly bounce back with $92,500. The seller says, “OK, where do I sign?”
When it happens fast like this, you always think you paid too much. Did you? Negotiating isn’t worth all the effort, unless you first know exact­ly what you need. Otherwise, it’s only game-playing.
Develop the Right Approach

One of the best methods for negotiating is what I call the “ColumboTechnique.” Lieutenant Columbo is the cigar-smoking detective on TV with the wrinkled raincoat. He doesn’t appear smart enough to ever solve a homicide case, yet he always does.

If you get the opportunity, watch Columbo solve a mystery. Observe how he does it. Let me suggest things to watch for. First of all, you should observe that Columbo is never intimidating or threatening. He never appears to be competing with anyone, yet in his own special way he quiet­ly and forcefully moves directly toward his goal, which of course, is solv­ing the homicide.
Real estate investors can negotiate in a very similar fashion, with equally successful results. You’ll notice that Columbo always has a specif­ic reason for everything he does. His questions are always supported by clues or information he develops. His attitude is courteous and he often seems apologetic when he needs to ask the tough personal questions. In fact, most people even go out of their way to cooperate with him because he’s courteous and seems genuinely concerned about their needs. Notice how Columbo steadily pressures villains into accepting surrender without putting up much of a fight. (I’ve never seen Columbo use a gun.) The rea­son is because he develops the facts and then confronts his suspect with hard, indisputable evidence, which makes a conclusion very obvious. He does it all without allowing his personal emotions to interfere.
His success in solving mysteries is in large part because he listens. Columbo asks short questions, then waits for long answers or explana­tions. That’s a very effective method for learning about other people and it’s just as true in real estate negotiating as it is solving homicide cases.

Practicing Columbo’s Winning Ways Can Help You

So, what can you learn from Columbo about negotiating to buy real estate?
First, before you start arbitrarily changing or negotiating terms and/or conditions, make sure you can show the reasons why. If you can’t, they’re probably not valid; worst of all, proceeding without being able to show why can severely damage your credibility. You don’t need that, believe me.
Second, it’s very important to listen to the other side. You can answer yes or no if you train yourself, but listening to others will provide you a wealth of knowledge and information that will help you structure offers or counteroffers. People love to talk. If you’re a good listener, you’ll be very popular with most folks. Columbo is very good at this. In fact, suspects often tell him enough to hang themselves. This makes his job much easi­er, wouldn’t you say?

Third, never get emotional. Don’t be critical and, above all, never talk down to anyone. If you humiliate, embarrass, or ridicule, you’ll lose all chances for negotiating a winning deal. Even sellers who are about to lose their shirts won’t do business with someone who intimidates or tries to overpower them. Courtesy and understanding are two of the most power­ful tools in your “negotiating kit.” Use them generously; they’ll pay big div­idends. Once again, Columbo is a master at this.

Winning Over the Seller Leads to Winning Negotiations
Consider the following exchange between a seller (owner) and a potential buyer, who were previously strangers.
Seller: Mr. Buyer, why are you offering me 25% less than my asking price? Buyer: Well, sir, the reason is that I know sellers always mark up their sale price because they expect offers to be lower! Obviously, you can still accept my offer because I think it’s much closer to the real value of your property. If you own a nice piece of property (your opinion) and you have worked very hard to fix it up and make it look attractive and then some buyer, a total stranger to you, tells you your property is worth 25% less than your asking price, what would you immediately think of him as a person? Chances are, your answer is not printable in this book. No one likes to be told their prop­erty is worth less than they think—even if it’s the truth. That’s human nature. You hurt their feelings and that hurts your negotiations.
Columbo never tells his suspects anything that would alienate them or stop the flow of information between them. He wins without shouting matches, embarrassing others, or making enemies along the way. These are excellent skills for any negotiator.

Play Games if You Want Real Benefits

Arbitrarily cutting the asking price is game-playing, especially for the rea­son given above. Obviously, if the price is truly too high, it needs cutting. However, you should have a justifiable reason to cut it. If you have done your homework and if you can reasonably demonstrate why your lower purchase price offer has merit, fine. Otherwise, it probably does not.

When your offer is considerably less than the asking price and you can’t explain why, it becomes very difficult to keep negotiations on a pro­ductive level. It’s sort of like saying to the seller, “You really don’t know what your property is worth, but I do!” If you mean it that way, you need to be in a position to tell the seller why.
I like to consider the terms I’m negotiating as if each one is a bullet in my gun and I have only so many shots. If I shoot at everything—that is, I attempt to change everything in the contract to suit myself, like asking for a lower selling price, smaller payments, a reduced interest rate, a longer mortgage term, less cash down, and even a different closing date—I should ask myself, “Am I shooting at the right targets or am I just wasting my shots, hoping to hit everything I can?”
Don’t win the negotiations and lose the bargain. I’ve known buyers who have done quite well at persuading sellers to reduce their asking price, only to find out later that the price was still too high. If negotiating is to serve a valid purpose, that purpose must be to make the deal work­able for everyone. It should not be a contest to determine who can have his or her way the most; otherwise, you’ll end up like the little Boy Scout who cut the rope three times—and it was still too short.

The Three Most Important Buyer Objectives

Here’s some advice you should pay particular attention to. It’s worth big bucks to every small-time real estate investor. In fact, if you do this right, you can quickly move up the financial ladder from “small-time investor” to “big-time, cash-flow tycoon.”
These are the three most important items you’ll ever negotiate for:
The purchase price
The amount of debt service (monthly mortgage payment)
• The length of time to pay the debt
You can give everything else away if you have to, but you must get these three items within an acceptable range.
Obviously, financial circumstances for every buyer will be somewhat different, so there can be a little variation in the numbers. I’ll show you how this variation might work for you as we discuss gathering income and expense data.

Your Chief Negotiating Tool
My chief negotiating tool is my income property analysis form. It’s a sim­ple form that develops a financial picture of the property I wish to pur­chase. It shows the financial situation of the property and approximately how much it will cost to operate the property. It also helps eliminate much of the emotion from negotiations. (The previous chapter explains this.)
Often, a seller will argue that he or she pays only $X each month for expenses. But, you’re certain that the numbers are short or his or her memory is fuzzy, a common seller affliction. When the analysis form is filled out properly, with the seller’s assistance, it’s difficult to argue the facts. Generally, the form tends to jog a forgetful seller’s memory.
It’s Always Best to Let the Seller Participate

I always ask the seller to help me gather the information I need to fill in the blanks on my income property analysis form. After all, the seller should know better than anyone, since he or she operates the property and pays the bills.

The object of working closely (negotiating) with a seller, using a tool like my income property analysis form, is to develop hard evidence, the written proof of income and expense data. By assembling all the financial numbers on a single, one-page form, in an easy-to-read format, you have a very convincing tool for seriously negotiating the three most important buyer objectives—the right price, the right amount of debt service, and the right length of time to pay the debt.
Just as Columbo does, you must verify all information.

My experience has been that sellers will generally provide accurate information about the gross income, but beyond that they become forget­ful. For example, when we reach line 2 of the form, “Vacancy Allowance,” hardly any sellers will admit to having vacancies. When they do, they claim vacancies are rare. This usually changes after I ask to see their Tax Form 1040 (Schedule E) for the past year. Hardly any property owners give the IRS the same dollar numbers they give to me.

No One Reports Too Much Income to the IRS

It’s quite common for investment property owners to be overly optimistic about their net rental income numbers. For example, the income proper­ty analysis form (Fixer Jay’s Six Ugly Houses, which follows at the end of this chapter) shows a total gross income of $2,100 per month. If the sell­er’s tax return, Schedule E, shows property rents of only $20,000 for the taxable year, my question is “What happened to the $5,200?” My guess is vacancies and credit losses (deadbeat tenants). Obviously, transitioning properties might have gone through rent increases since the last tax filing; however, that’s fairly easy to determine.
The important point I’m making here is that investors should never allow less than 5% for vacancy loss or less than 5% for uncollected rents (deadbeats and skips). With rundown income properties, the percentages are often much higher.

Verify the Actual Expenses
I have found what works best is to have the seller provide proof of all expenses. The checkbook register or expense journals will generally pro­vide this information. Expenses that need to be verified are costs for utili­ties, management fees (if managed by someone other than the owner), repairs, maintenance, and property insurance. I also want to see the coun­ty tax statements. In California, taxes are adjusted to approximately 1% of the sale price when a property is transferred (sold).

Expenses the Seller Is Likely to Argue
As I’ve mentioned in the last chapter, property sellers have told me there are no management fees or maintenance and repair expenses on this prop­erty.“I do it all myself,” they say. My typical response is “Will you continue doing it, for the same price, after I become the new owner?” I’ve never had a single taker yet.
Then I ask, “How much would you charge me to manage the proper­ty, if I buy it from you?” No one has ever told me less than 10%. Most won’t take the job at any price. After a short discussion, they agree that my 5% management fee allowance is, indeed, very reasonable. After all, who will do it for less?
No one has ever developed a method for doing repairs and mainte­nance without spending money. When things break, it costs dollars to fix them. Painting, patching roof leaks, yard work, cleaning carpets, and patching walls are just a few of the maintenance and repair activities nec­essary to keep income properties doing what they’re supposed to do—gen­erating income. At the very least, you’ll spend ten cents out of every rent dollar you collect for maintaining the property.
Don’t include capital items like replacing carpets, coolers, and roofs, as that’s not maintenance or repair. Repair expenses—things like fixing broken doorknobs, cracked toilets, and broken windows—will cost you approximately 5%.

Remember: these are the numbers I use on my income property analysis form. I consider these bare minimums. I rarely have any difficul­ty convincing sellers. Sometimes their own expense records, Tax Form 1040 Schedule E, will show higher numbers than my estimates.

Favorite Concessions for Buyers to Ask For
When homeowners become more motivated to sell because of problems with tenants or for personal reasons (see Chapter 5 for more on common reasons that motivate sellers), it’s much easier for you to tighten up the deal. (“Tightening up” means asking for more concessions.) Owners will give maximum concessions to buyers who can both fix up junky, rundown properties and handle deadbeat tenants. Not everyone can, and even fewer are willing, so there’s a strong demand for talented problem-solvers.
It’s the same principle used by the famous oil well firefighter, Paul (Red) Adair. He requested and received astronomical sums of money for capping gas fire blowouts on oil wells, simply because he did it very well and because there were only a few others who even wanted the job.
You may recall it was Adair who was summoned to the North Sea to extinguish the raging fire and to plug leaks at the world’s largest oil field disaster—the Piper Alpha Platform explosion that killed 166 men. It was also Adair who was hired to cap the flaming oil wells in Iraq, set purpose­ly on fire by Saddam Hussein during the Gulf War. Do you suppose the folks asking for help were very concerned about Adair’s fee schedule?
In the same way, many sellers with problem properties will be moti­vated to work out a good deal for someone who can relieve them of their problems. Here are several of my favorite tighten-uppers:
Deferred mortgage payments until property is fixed up or until all deadbeat tenants are evicted (generally no mortgage payments for six months).
Longer mortgage terms with less interest. Also, ask for delayed pay­ments on owner carryback notes. Often you can get motivated own­ers to wait several years. This is a great way to improve operating cash flow when you acquire a property.
Larger discounts on the purchase price, especially when deadbeat tenants occupy junker, rundown properties. Let the bikers help you buy cheap.

Typical Negotiations Work Like This

In my town, owners will expect to sell an older income property, like the Six Ugly Houses example in this chapter, for about seven times the gross income ($2,100 per month times 12 months equals $25,200, times seven for an estimated value of $176,400). Generally, they won’t sell for a lower amount unless circumstances are unusual.
To find the actual dollar amount left each month to satisfy any new debt obligation for this example, take a look at line 14 of the income prop­erty analysis form. There are two existing mortgage payments totaling $795 per month (line 13A). The total mortgage balance is $100,000. Line 14 indi­cates that I would have $240 to pay any additional costs for the property.

Let’s say I’m willing to give the seller a note or mortgage with payments of $240 per month (all that’s left over); however, at 10% interest, the note could only be for $28,800 (10% times $28,800 equals $2,880, divided by 12 equals $240). If I agree to that and if the owner insists on a selling price of seven times gross ($176,400), I would need to come up with a $47,600 cash down payment ($100,000 existing mortgage debt, plus $28,800 new seller carryback note, plus $47,600 cash down equals $176,400).

A 10% down payment is generally the acceptable amount for older income properties. It’s also about all I am willing to pay down for ugly fix-up properties. So, in this case, I might offer $175,000, with $20,000 cash down, and ask the seller to carry back a note for $55,000, payable at $250 per month (interest only) for a term of 10 years minimum. (I would try for 20 years.)
If the seller says $250 per month is not enough payment for his $55,000 note, I would ask him, “Where do you expect me to find the extra money? After all, I’ll be paying you $10 more per month than the proper­ty is earning right now. Are you asking me to reach into my pocket every month to pay you more money than the property earns, when I’ve just paid you $20,000 cash for the privilege of owning the property?”
That’s a hard question for sellers to answer. They look at the property analysis form, then they stare at the $240 on line 14. They might mumble something like “Maybe you won’t have too many vacancies or credit losses. That would give you 10% more income” or “Perhaps you would consider giving up your 5% management fee. That’s $105 per month” or maybe even “15% for maintenance and repairs? That really sounds too high.”
The real value of my form is that when you and the seller have taken the extra time to agree on expenses and to fill out each line together as a joint effort, it’s extremely difficult for the seller to go back and ask to undo the results. The seller doesn’t like the low payments on his carryback financing, but he can accept them much more easily when the form shows that $240 is all that’s available to pay him.

Don’t talk about interest rates; discuss only how much money is avail­able to pay him or her. Most sellers are willing to take back low interest notes (mortgages) as opposed to reducing their selling price. I’ve found that it’s very difficult to get a lower sales price and offer only a 10% down payment. The risk of losing a good income property is much greater when cutting the price than when negotiating the seller into a “soggy note” or mortgage. (“Soggy” means a low interest rate or weak terms.)

Successful Negotiations Put Money in Your Pocket
If you are a do-it-yourself operator (you manage and do maintenance and repairs) and if you can negotiate a deal similar to what we’ve been dis­cussing, you’ll be in great shape. You’ll own a property that has cash flow when you buy it or shortly thereafter.
Your profits will be enhanced by rent increases, and by minimizing vacancies and rent losses. Don’t forget the monthly 15% maintenance and repair allowance ($315 total in our example): 30% of that ($95) will go for buying materials and 70% ($220) is labor—that’s you! When and if you sell, the soggy seller carryback mortgage you’ve negotiated will allow you to sell for a premium price. Good financing is worth extra bucks because you can sell with good terms to the next person.

Note: Line 14 shows available funds to service new mortgage debt from operation of property.

Remarks: All lines must be completed for proper analysis. Enter the actual amount on each line or 0.

Read next Fixer-Uppers part 11

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