Chapter 6

Making Offers

Do your due diligence, figure out your estimated after-repair value, and work backwards from there.

The rule of thumb for buying flips is to multiply the after-repair value (ARV) by 70%, and then deduct the cost of any repairs needed to renovate the property. This number will be your offer.

If you’re able to buy at this price, then you should be in good shape. The 30% difference between your offer and the ARV should go to:

10% to holding costs (utilities,property taxes, insurance, loan payments)
20% to profit

Let’s say you find a house that would sell for $300,000 after renovation.

If the renovation costs $40,000, then you should offer $170,000.  

$300,000 x 70% = $210,000 - $40,000= $170,000

This should leave you with $90,000 to go towards holding costs and anything left offer goes in your pocket.

Always be conservative with your numbers.  Don’t expect to sell your projects for top dollar and build in plenty of room for error in your renovation budget (10% on top is typical). You can’t fudge your numbers, sometimes things will work out great but one bad deal can torpedo your business.

A good piece of advice I was once read was to only make offers that you’re almost embarrassed to make. Grimacing with uncomfortable awkwardness while making an offer is a sign that you’re not overpaying.    

If you’re looking for a rental property, then you say something like:

“Great, thank you for your call.  I’m looking to buy rental property in Dealsville, I’d be happy to take a look at anything you’d be willing to show me.”

They’ll probably have a couple questions about who you are, so try to have something ready to say.  Don’t worry about getting all the details about the property over the phone.  You should be able to find most info online once you know the address and can figure anything else out when you see it in person.  

Try to see prospective rental properties during the day when tenants are most likely at work.  That way you can get a better look at the apartments without feeling like you’re intruding on somebody’s peace and quiet.  You don’t really need to meet tenants to know what they’re going to be like—you should be able to get a feel for them just by walking through their living space and seeing how they keep it.

After viewing a property, tell the seller that you liked the place and need a day or two to run numbers.  Try to avoid making an offer on the spot.  It’s best to detach yourself from the property, look at comps again, run another income/expenses sheet, price out any repairs needed, and avoid saying a number that you’ll regret later.

Look for properties that cash flow for at least a 15% return on your down payment.

For example, if you put down $70,000 to buy a property, then you should net at least $10,500 after paying expenses.

Here are the expenses to include in your valuation:

-Principal payments on your loan.  This is the part of your mortgage payment that actually comes off your loan balance.  Paying down your loan balance is called building equity, and it’s more or less just putting money in the bank.

-Interest payments on your loan.  This is the part of your mortgage payment that goes to the bank.  It’s how the bank makes its money.  It will start off as a high percentage of your mortgage and become a smaller percentage overtime compared with the portion that goes towards the principal.

-Taxes.  Your property is in a town or city, and that town or city will charge you a property tax.

-Insurance.  You need to find an insurance company to insure your property against loss.

-Utilities.  A landlord pays for any utility that is not separately metered by unit.  Otherwise, there would be no way to accurately judge how much one tenant should owe.  Try to buy properties that have separate meters for heat, hot water, and electricity. Tenants who are responsible for paying their own bills tend to be more conscientious about conserving energy usage.  It’s less common to separately meter water/sewer-- expect to pay for the water/sewer yourself.

-Annual Expenses.  These are things like landscaping, snow removal, cleaning, small repairs, etc.  I usually calculate this line item to be about 10% of my overall cash flow.

-Capital Expenses.  This is a money that you save up towards larger repair items like a new roof, heating system, or any other major renovation.  All components of a building have a working life expectancy and they will all fail eventually.  You need to always be putting money away so you’ll be ready for a $20,000 repair when it comes up.  You can’t negotiate with a leaky roof or an apartment without heat in the winter, so you must be prepared to financially deal with this kind of catastrophe when it happens.  Figure in 10% of the gross income for older buildings or 5% of the gross income for newer buildings.  

-Vacancy Loss.  It’s normal to have an apartment go vacant for a month here and there.  Sometimes you’ll just need some time to do some fixup work and sometimes you’ll have a tenant leave unexpectedly.  Either way, don’t plan on every one of your units to be rented 100% of the time.  I usually use 5% of the gross income for vacancy loss, but you might need to adjust it based on the location of your property.

Quick note-- some people also include a line item expense for property management, typically for 8-10% of the gross income.  I do not, I manage my properties myself and don’t feel the need to include it.  My dream is to one day hand my keys to a property manager, but for the moment, I’m too greedy.

Do yourself a favor, make an excel spreadsheet to quickly calculate cash flow.

Always run numbers through this spreadsheet and let it do the thinking.  You should be able to judge whether or not a property is a good deal or a bad deal within a minute or two once you have your spreadsheet put together.

Here is a copy of a simple one for reference:
After you identify a good deal, then it’s time to make an offer.  

I always avoid round numbers, like $500,000 or $250,000.  I much rather prefer coming in with at a random looking number, such as $492,500 or $253,500.  There’s a psychological reason for it—it gives the impression you’ve put a lot of time into coming up with the offer instead of something that you’re firing off from the hip.  

If people think you’ve done a lot of data crunching to formulate your offer, they’re less likely to think you’re trying to negotiate.  When they counter, don’t respond right away.  Give it a day and go back to the seller with another random looking number.  If they ask why you’re using such a seemingly random number, then say it’s literally the last dollar that your system allows you pay.

Keep in mind that there are thousands and thousands of homes out there and you do not need to buy any one specific property.

Don’t fall in love with a deal to the point that you end up overpaying. Stick to your criteria for making offers and be ready to walk away if the deal doesn’t fit your models.  

You make the majority of your profit by buying low, and you don’t want to end up in a “skinny deal” that locks up your time and money and prevents you from jumping on potential home run deals.  This is called opportunity loss—remember that we’re looking at 100 houses, offering on 10 houses, and buying 1 house.  We are not trying to buy every house.

Regarding cash offers: I do market to properties that I can pay for out of pocket.  

If you don’t have that kind of money on hand, it’s okay. You can still offer to buy places all cash because hard money loans are considered the same thing as paying cash. Your offer will not be contingent on financing, so the seller will be able to keep your earnest money deposit (usually anywhere from $1,000-$5,000 depending on the property) if the hard money lender refuses to give you the loan.  

Getting denied is unlikely if you’ve done your proper due diligence and have negotiated a good price.  The loan processor might need to do a quick walkthrough of the property to make sure the building is how you described it and the seller might need to provide some info to the lender, but that’s about it as far as the burden placed upon the seller goes.  Again, much less than a typical sale and they can still get a check their check in a couple weeks.  

If you’re looking for a rental property and end up agreeing on a price with a seller, then a hard money lender probably isn’t your best option.  You would need to pay high interest, closing costs, points up front, and then need to pay closing costs again when you go to refinance into a traditional mortgage.  

It’s okay to do this if you find a good enough deal, but it’s not ideal. In these situations, I tell the seller that we ended up agreeing on a higher price than I expected, and as a result, I’ll need to get a loan from the bank.

This is usually an easy sell provided they can wait 30-60 days for a conventional mortgage to close.  They still don’t need to deal with showings, inspections, and can sell their home without going through the hassle of formally listing it.

If that’s not a possibility and the deal is good enough, then it’s time to look for a partner.  

You’ve done a lot of work getting a profitable deal teed up, and there are many investors with deep pockets who actively look for provide financing for profitable deals either as a partner or private lender.  Go to real estate meetups, post on biggerpockets.com, call your friends or family, and don’t be shy.  You’d be surprised how many people with money are looking for places to make more money.  Many successful investors got their start kicking up deals for other people.  It’s called bird-dogging, you do the work of finding deals in exchange for a flat finder’s fee or equity in the deal.

If the deal is good enough, you will not have trouble finding the money to pay for it.
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