When to Look A Gift Horse In the Mouth
by Ron LeGrand
Many investment courses and books on real estate (mine included) tell you to find a motivated seller. That’s where you get your good deals. As a rule, that’s true. The higher the level of motivation, the more likely you’re going to get a good price or good terms or both. But generally, when you find a motivated seller offering a good deal, you should take a moment to look that gift horse in the mouth. Ask hard questions about why a seller is motivated. Here are some examples of good opportunities that shouldn’t necessarily motivate you to buy.
Caveat Emptor Let The Buyer Beware
The seller advertises a fixer upper, but it isn’t. Yes, it could use new paint . . . and new carpet would make it look tremendous, but that isn’t the real problem. The reason they’re trying so hard to sell this turkey is because the floor plan doesn’t work. In fact, it’s what we call functionally obsolete.
When you buy a house to live in, you pay a lot of attention to the floor plan. Unfortunately, many people looking for rental houses or small apartment units don’t pay enough attention to the floor plan. Look through the property as if you were going to live in it. Would you be happy with having to go through the kitchen to get to the master bedroom? Or through a bedroom to get to the kitchen? How about a bathroom that is attached to your kitchen? A ceiling less than 7?? high or a house that’s literally sitting on the ground with no concrete slab blocks or piers underneath.
I have seen all these problems in houses and so has everyone else who has looked at more than a few properties. I saw a house recently with 33 rooms. About two-thirds of them were added on as more relatives joined the family, and none of the additions were constructed properly. Most were just sitting on the ground and the additions jutted out in all directions from the original building.
I felt like a rat in a maze just walking through the place. It was a unique experience. The sellers had refinanced and had maybe 15% equity. I can’t picture anyone buying it, but maybe they’ll get lucky and a family with a herd of kids will come along and want it. By the way, when I visited the property, there were nine families living there. I wouldn’t even take a deed for free if I had to promise to make the payments.
Your tenants and buyers won’t like these houses either, which will make it harder to rent or to sell. This is not a fixer upper; it is a major problem. Too many people get into fixer-uppers when they’re not prepared, and over-doers do the wrong things. The point here is learn to tell the difference between a fixer upper which needs rehabilitation or modernizing versus a property with major problems that a rehab won’t fix. On the other hand, a lack of knowledge concerning what appears to be major problems can cost you big, as well. For example, most investors will not take on houses with structural problems. Having the knowledge to do repairs, but not doing them, can be a costly mistake.
What are structural problems? Basement walls caving in, houses on piers that are sinking, Concrete slabs cracking and sinking. I could go on and on. All houses must have a foundation. These are most commonly constructed of either concrete or wood.
These are relatively cheap materials and the labor to replace them isn’t nearly as costly as some of the horror stories you’ve heard. If you use the right people and do a little front end due diligence, you should be able to get a good deal. Actually, it’s no different than any of the other repairs. You can hire one roofer out of the yellow pages and pay him $2,000. Or you can call the guy on the next page and pay him $5,000 for the same job. That’s rehabbing, baby.
If you insist on being a sheep, you can count on getting sheared. If you’ve ever watched a guy jack up a sinking house sitting on piers, you’d understand how very little work it really is. It’s usually easier than changing a tire on your car. If you don’t understand this, you’ll overpay and that guy will be laughing at you all the way to the bank. Baaaaaaah!
Owner anxious, will accept nothing down. I love that. Even if I were willing to put cash down, this ad would catch my eye. These people have declared themselves as numero uno flexible sellers. Or have they? Again, you need to analyze the seller’s motivation. Why are they offering such a good deal? Is it because they have to compensate for something that’s drastically wrong with the property and can’t be changed, like a bad location? Maybe the house is the one out of 500 hundred properties in the subdivision that backs up to the expressway on one side and the convenience store on the other.
The sellers had two options, either cut the price drastically or improve the terms. And the easiest way to sell is to offer it for nothing down. The seller knows that the less money you’re able to put down the less particular you can be. And, if the only thing you think about is nothing down, you can be easy prey to someone who has a property that’s poorly located or has a bad floor plan or needs major repairs.
Right Things Wrong
If you’re going to look for good deals resulting from property problems, look for a property with all the right things wrong with it. My favorite problem is filth. I love filthy properties. You can’t sell a filthy property for what it’s worth until it’s cleaned up and the discount is far more than it costs to clean it.
I love rotten wood, overgrown shrubbery, tall grass, broken glass, peeling paint, bad roofs, missing doors, broken toilets overflowing with waste, cockroaches, fleas, spider webs, dead animals in the house and the smell of cat urine. In fact, I want the house to smell so awful that most people won’t go inside. I like it when you open the door, the odor takes your breath away and makes your eyes water. All these problems are easy and relatively cheap to fix.
These are the right things wrong. So are those foundation problems. If you can visualize the repaired house and calculate its value compared to your purchase price, that’s the point where you begin to be able to purchase houses for 30-60 cents on the dollar. It’s like that old saying about not being able to see the forest for the trees. Look past the obvious problems. Learn to recognize the opportunities.
When it’s not the house that’s wrong
One example of the kind of seller motivation you CAN live with would be a change in circumstances. A classic example is somebody who puts their house on the market knowing they are going to be transferred in 90 days. They find out several days later that the transfer will be in nine days. The company needs them at the new location early and the homeowner agrees to go if the company will absorb the difference between what they have to sell the house for and the recently appraised value.
By the time you run across them they’re running around like a bird with its tail feathers on fire looking for a bucket of water. They want a buyer, and they want one fast. Not only is this seller motivated, they don’t have to worry about how much is lost in the transaction, within reason.
I can think of lots of examples of changes of circumstances. These would include health, divorces, marriages, new babies, job opportunities or firings. But here I’m talking about a person who wants to sell the property to solve the personal problem. I am not talking about a person with a problem property that wants to pass the problem on to you.
The “I Quit Syndrome”
Some sellers finally give up. I’ve seen them lose hope, throw in the towel and throw the price out the window, all at the same time. Let’s build an example.
The seller has the house on the market for $120,000 when it’s only worth $105,000. They have a loan balance of $95,000. There are literally hundreds of houses available in that price range so no one even bothers to make them an offer. With things selling left and right around them for a nine month period of time, and the listing expiring for the third time, they finally decide to do a for sale by owner at $95,000. You come in and offer to take over their loan ‘subject to’ and they finally say I can’t stand it any more, I quit, and it’s yours. Now it would seem there is no way to make yourself available for a deal like this unless you try to be the last person to make an offer. There is a way you can be.
Persistence In All You Do
If you find a property you like but it has a price you don’t like, go ahead and make your offer but also make several copies of it. Every two weeks send the seller a reminder (if he or she wants to come to their senses). Maybe a better approach, one that I have used, is to send the offer every two weeks and say?today I am going to re-offer what I offered before. Sign it within 24 hours and we have a deal, otherwise look elsewhere. If you contact them a couple times like this, you might be surprised, and one day they just might sign what you sent them.
In many cases people don’t buy until they’ve been asked to buy several times. I suppose this is the same with sellers. If the seller is not getting exactly what they’ve asked for, they want to sit around for awhile and find out what other offers are going to be made. When the offers stop, their mood changes. If they are sitting around and feeling disheartened because nobody has given them a realistic offer, and you’ve been consistently interested, they might just call you.
All sellers’ minds will change with time and circumstance.
Real estate investors have to wear two hats. They have to be optimist and chase down every potential property, especially those that look like a bargain. But they also have to wear the hat of the pessimist and learn to ask enough questions and listen closely enough to the answers, to find out why the sellers are motivated. Persistence pays and bargains are to be had. Just make sure you find a true bargain and not somebody else’s problem. You don’t want to make it yours.
Now let’s talk about another gift horse you need to watch out for. I have seen a lot of houses lately in the upper price range (200K and up) with absolutely fictitious appraisals. A seller calls you with a deal and says their house appraised recently for $450,000. They have a loan balance of $360,000 and just need debt relief. You see $90,000 in equity just waiting for you to come and get it, so you go get the deed or lease/option and agree to start making the $2,800 payment.
After the dust settles and the excitement dies down, you start doing your due diligence and learn the value is really nowhere near that $450,000. In fact, you can’t find any evidence it’s any higher than the loan balance. Then you discover the appraisal the seller showed you was done by a lending institution for refinancing. You then see your $90,000 blowing away in the breeze. Now all you need to do is find someone you can unload this turkey on; the first person who’ll offer you more than the loan amount. Not a bad seminar, but a hard lesson nonetheless.
Always independently verify the value of a property yourself, especially on high-priced houses. Never accept an appraisal from the seller as reality. It’s not that the seller was pulling a fast one. Usually they don’t even know. The problem is there’s such a glut of money available for funding loans the competition is fierce and lenders are really pushing hard to close loans.
I can’t honestly say I know exactly where the weak link is, or why it’s become so common. But I can tell you within the last 6 months, I’ve seen high price house deals cave in because the value was not there, yet a refinance appraisal said it was.