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The Art of the Deal

This post may be a little off topic, but since I have written several posts on real estate investing, I thought it might be helpful to explain one of the most important skills I have developed over the years. This post will be about the basics of how I negotiate real estate transactions.

When you buy or sell a financial security such as a mutual fund or a stock, there is no negotiation involved. The transactions occur on a large electronic market in which no one knows who is on the other side of any transaction.

However, purchasing real estate is different. Although you may not know who the other party is on the other side of the transaction, you do know it is just one party. It is also possible you can find out salient information about the other party that can assist you in negotiating the sale or purchase. In addition, in real estate sales there are brokers involved, which brings more personalities to the transaction that you can use to your advantage.

Negotiating the best deal you can get in a real estate transaction is important. Even though you may be putting a small amount of your own money into the deal, the transaction itself is very large. If you can buy a $200,000 property for 5% less through skillful negotiating, that is $10,000 that went into your pocket that otherwise might not have.

Also residential real estate negotiating for an experienced investor is easy pickings. Generally, you are dealing with people who are both inexperienced and often emotional about their real estate transaction. And believe it or not, most realtors are clueless when it comes to negotiating transactions as well.

When I purchase real estate, it typically is a 2 to 3 week process. I go through stages of “setting up” the buyer (or seller) and slowly undermine their position. A lot of it is psychological. As a result, I always buy real estate at wholesale prices and sell real estate at high retail prices.

Of course, the most important step in buying or selling real estate is to be on the right side of the transaction at the proper time in the market cycle. The chart in this previous post explains the long term real estate cycle of the last 20 years and the best time to buy or sell. When you purchase investment real estate, it is imperative that you purchase at the proper time in the larger cycle to be able to make the investment work from an income standpoint.

I will not go through the process I use when negotiating a real estate deal as each transaction is different. But I will provide a few pointers that may help you in negotiating your next real estate transaction of any kind. Some of these ideas will be common sense to most people, but you would be surprised how often they are not practiced. This may be because, when most people buy or sell real estate, they are dealing with their primary residence and it is hard for them not to be emotional about it.

So the most obvious suggestion when it comes to a real estate transaction is do not get emotional about the purchase or the sale of real estate. You will be a certain loser in any transaction if you do.

The first official rule of real estate negotiation (or for that matter any asset where there is one buyer and seller negotiating) known by all skilled negotiators is, “He who wants the deal more, loses.” If you want the deal to go through more than the other party, he will likely get the best of you. But if you do not care if the deal goes through, why would you even get involved. Let me clarify this first rule, “He who shows they want the deal more, loses.”

When it comes to real estate, the best way to be in a position where you do not care about the deal is to actually not care about the deal. My recent home sale was the perfect example of this as explained in this post. My wife and I got an unsolicited offer to sell our home and we really did not care if we sold it. We eventually did sell it because we got a premium price and an all-cash no contingency contract. Otherwise we would not have sold our home.

We were on the other side of the transaction a couple months later. We had no intention of buying any real estate for at least a year. However, we were having lunch in a small town in Maryland and we saw a two unit property for sale that seemed like it would make a good rental. We called the realtor and toured the property. We made a very low offer to purchase the property. After I took a couple weeks to examine all the costs and income potential, we purchased the property at a price where I knew the investment would work. The important point here is that if the seller had not agreed to our purchase price, we did not care; we would have just withdrawn from the negotiations. I guess a corollary to the first rule is you should never be in a rush to buy anything.

Obviously, in order to put yourself in a position where you “want the deal less” than the other party when selling real estate, you can’t let yourself get into a financial situation where you have to sell in the first place. After the real estate bust of the last decade, a lot of people were in this situation due to job loss. You cannot do much about a situation like that, but I have seen people get into trouble in real estate transactions where there was no outside force.

The most common place I have seen people un-necessarily introduce risk into real estate transactions is when they are looking to move and they fall in love with a property for sale before they have sold their existing home. I am assuming that anyone reading this blog is smart enough to know not to make a “non-contingent” purchase offer before they have sold their existing home. However, even if you make the offer to purchase the new home contingent on selling your old one, I think this is still a mistake that really undermines your negotiating position in a couple ways.

The first way is the contingent offer itself. In a slow real estate market like we are experiencing today, the seller often views a “home to sell” contingent offer as no offer at all. If the seller accepts the contingent offer, they will probably require you to pay full price for the property. Unless this is the only house in the area that will suit your needs, I think it is best just to wait until your existing home is sold.

The second reason why contracting to buy your new home before your existing home is sold undermines your negotiating position, is that your focus changes to your new home and away from your old home. What I mean by this is most people begin to look forward to their new life in their new home. This is normal. However, when you do this, you start to undervalue your old home. This is a subconscious action that often results in accepting a lower price than you might otherwise just to “get rid of it.”

If you get nothing else out of all the posts I have written in the area of real estate, please never purchase your new home until after your old home is sold and the funds are in the bank. In today’s real estate market making non-contingent offers, especially cash offers, often gets you a 10% – 15% discount on your purchase without much resistance from the seller.

I know waiting to sell your old home first may mean some inconvenience to you and your family such as renting a short term apartment. But I can assure you that you will end up with a significantly better equity position if you follow this one piece of advice.

For example, assuming you are selling a $200,000 home and buying a $300,000 home, a 5% higher price on the sale of your old home and a 10% lower price on the purchase of your new home equates to a savings of $40,000 on the two transactions. How long would it take you to save $40,000 out of your monthly paycheck?

When buying real estate as an investment, I have a few standard rules for all properties I may be interested in:

1. The first rule is to know the highest price I will pay for the property. That is, the price where I know the investment will work.
2. I never let the realtor I am working with know the highest price I am willing to pay; there is a 100% chance they will tell the seller’s agent and the seller. In fact they have a fiduciary responsibility to do so.
3. Another rule is, before I even make an offer, I try to be sure there are no other buyers interested in the property. If I sense there may be other interest, I do not make an offer and move on to the next property (although I may come back to a property a few months later if is not sold). I am not interested in competing with other buyers.
4. I prefer properties that are vacant as this usually means somebody is making two mortgage payments.

During the negotiations of a purchase, there are several tactics I use depending on the situation. I will describe one tactic below that I use in most negotiations.

When buying real estate there is usually two real estate agents involved. Unless you have made special arrangements, they both have a fiduciary responsibility to get the best price for the seller. However, the realtors are obligated to treat the buyer fairly (which really just means they must present facts to you about the property accurately). However both realtors involved have one main interest, that is to make the deal go through or they will not get paid. I use this fact to my advantage in negotiating a purchase.

Typically, most real estate transactions take several back and forth offers and counteroffers before a contract is signed and ratified. During these back and forth offers in order to try to get the deal to go through, the realtor(s) always work hardest on the principle who they think has the weakest position. For example, if the realtor senses that the buyer really wants the property and the seller is firm on their price, the realtor(s) will work on the buyer to get their offer price higher. Conversely, if the realtor(s) think the buyer is firm on their price and the seller really would like to sell, the realtors work harder on getting the seller to come down in price.

Your goal as the buyer is to let the realtor know, you are not interested in raising your initial price to purchase. Of course you can just tell the realtor you will not go higher in price, but most experienced realtors will ignore it as they have heard this before. The best way to let the realtor know that you are firm on your price is to send the realtor subtle signals. How does one do this? There are several ways.

When I make an offer I always have two properties that I am looking at. During negotiations I let my realtor know that if this deal does not work out that I may make an offer on the other property. I do this even if I have no interest in the other property. This casual statement lets my realtor know I am not in love with this property and I am prepared to walk away from the deal.

If your realtor thinks you will move on if your price is not met, they will work extra hard on getting the seller to lower their price. Why do realtors react this way? Because, knowing how hard it is to get buyers to make an offer, realtors view a current offer as a “bird in hand is worth 20 in the bush.” This one tactic has saved me tens of thousands of dollars over the years negotiating real estate purchases, boat purchases, etc.

Another tactic I use a lot is when I get a counter-offer from a seller and I am willing to go up a little bit in price, I wait 3 or 4 days before I make my counter-offer. I make up some excuse like I am checking property insurance rates or local utility bills, etc. This delay really unnerves your realtor. They call you every day. It also really softens up the seller. It again sends a signal to everyone that you are not in any hurry to own this property. With one exception every time I have used this delay tactic, the seller accepted my token counter-offer.

There are many other negotiating tactics you should learn if you are going to be a real estate investor. There are also many good books on the subject.

There is an old saying in real estate that has a lot of truth, “When owning real estate as an investment, the money is not made when you sell the property, the money is made when you buy it.” That means mastering the “Art of the Deal.”

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