Negotiating Deals and Avoiding Scams in Real Estate Investing

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Negotiating a successful real estate deal (Photo by 'dhendrix73')
Negotiating a successful real estate deal (Photo credits are located at the end of this article.)

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Introduction: Residential and Commercial Real Estate Investing 101 (Part 4)

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Hello yet again, and welcome to the fourth (and final) installment of Residential and Commercial Real Estate Investing 101!  Over the past three articles, we’ve discussed many of the core aspects of real estate investing that you should be familiar with, and it is almost time for you to fly from the nest.  But before you embark on the long and prosperous voyage that will one day lead you to ludicrous, Donald-Trump-like wealth (sans the ludicrous, Donald-Trump-like hair) — or failing that, at least financial security — I want to cover a few final things.

Donald Trump is known almost as well for his ludicrous hair as for his vast wealth! (Photo by Gage Skidmore)
Donald Trump is known almost as well for his ludicrous hair as for his vast wealth!

To begin, we’ll spend some time talking about tips and strategies for negotiating the best real estate deal that you possibly can.  Then, I’ll discuss some unethical and unsavory Realtor/seller tactics that you should be on the lookout for.  Lastly, I’ll warn you away from lackluster property investments (i.e., scams) that are almost guaranteed to lose money.

Note: If you missed the first three articles, don’t worry — this tutorial may be read in any order.  Plus, I have placed links to the first three installments below:

Negotiating a Good Deal

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In order to find properties that are undervalued, you’ve got to be ready to do your homework.  Fantastic real estate investments don’t just fall from the sky — and that’s a good thing.  Otherwise, more investors would undoubtedly meet their demise like the Wicked Witch of the East! (Snare roll, please?)

Using the techniques for valuation and cash flow analysis discussed in Part 3 of this tutorial, you should be able to find an attractive property listing with enough persistence and hard work.  However, the seller of a property in question and his or her agent may not share your thoughts on fair market value.  The reality is that, many times, real estate listings are overpriced.

'The Charlatan' by Pietro Longhi (c. 1757)
Charlatans have peddled their wares since long before the first real estate deal was made!

In such cases, unscrupulous sellers and agents will only mark down their listings — to slightly less absurd asks — after nobody buys.  Even then, it is common practice to promote such ambiguous price reductions like a fire sale advertisement (even though the properties may still be overpriced)!  That is one of the reasons why it is so important to perform the due diligence on a potential investment before entering the negotiation phase, so that you may have the necessary leverage to intelligently talk down inflated asking prices point by point.

Some real estate investment professionals will advise new investors to seek out and take advantage of homeowners in dire financial straits, by offering the poor folks absurdly low amounts of money for their properties. (Unfortunately, many people don’t know that they may avoid losing their homes simply by filing for bankruptcy) These particularly odious snake-oil salesmen/saleswomen don’t seem to be bothered by the moral ramifications of such despicable business practices.  Luckily, alternative methods for ferreting out great real estate deals in an ethical fashion are available, for personal investors who are patient, persistent and willing to spend the necessary time doing research:

  • Work With Motivated Sellers — Motivated sellers don’t want or need the real estate they put up for sale, for any number of reasons.  Examples include people who have been willed property from late family members but cannot be bothered by it, or who have recently purchased new homes and no longer need their old ones.  Sometimes motivated sellers are identified as such in real estate listings, though not always.  Be patient and look at many different properties, and you will eventually match a desirable investment opportunity with a motivated seller — just be sure that you have financing available when you identify a good deal! (Note: A motivated seller is not the same as a desperate seller! See ‘Earl’s Insights’ a bit further down.)
  • Look for “Diamonds in the Rough” — You might be surprised to learn that properties with cosmetic flaws (e.g., in need of a fresh coat of paint, new carpeting, attractive landscaping or even a mowed lawn) are sometimes undervalued.  Such superficial touch-ups aren’t time intensive and can even be fun — if you don’t mind applying a little elbow grease! (Contrarily, you can hire out the necessary work.) Higher curb appeal equates to higher rents/re-sale value.  Just be sure to include the estimated expenses for minor improvements in your cash-flow analysis, as well as the loss of any rental income (if applicable) that you will miss out on if the property must remain vacant during the renovation period.
  • If You Can, Buy During Hard Economic Times — When things start looking bleak (economically speaking), many short-sighted investors will panic and try to liquidate their real estate holdings.  They reason that things can only get worse, and that it would be better to cash in when prices are merely down, rather than wait for the market to hit rock bottom and lose everything.  However, the savvy forward-thinking investor will realize that housing market prices rise and fall just like stock market prices, and buy during an economic downturn for a real bargain!  Also, when you purchase real estate at a discount, you may very well find it less difficult to attain positive cash flow yields in the beginning.
  • Check for Zoning Opportunities — Recall from Part 2 of this tutorial that the zoning status for properties can change.  Sometimes, this may work in your favor.  For example, larger single-family homes might be converted into duplexes (or triplexes), and multi-unit apartment buildings could be converted into condominiums.  Municipal planning offices will be able to tell you whether or not a property’s zoning status may be changed in such a way.

Earl’s Insights: Distressed Properties Defined

Distressed Properties — These are properties that have been, or are in danger of being, repossessed by banks and other lending institutions after their owners fall behind on mortgage payments.  You may have heard about distressed real estate through avenues of questionable integrity (e.g., email spam, flashy internet ads, late-night infomercials), wherein smooth talking gurus claim to have devised sure-fire strategies for gobbling up undervalued real estate for huge profits.  You can easily make millions doing the same, say the gurus, but only after you purchase their books and/or video courses!

 However, these hucksters often make distorted promises, and their advice invariably boils down to so many variations on the “sucker’s bet” theme.  My advice is to shun anyone and everyone who promises you an avenue to easy riches. (Author’s note: Due to the open-auction style ad placement system used by Google AdSense, you may even see such “guru advertisements” on this page from time to time! See disclaimer on my homepage.)

Avoiding Real Estate Investing Scams, Borderline Scams and Money Losers

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There are certain real estate investments that should generally be avoided.  As mentioned in the previous section, the most blatantly obvious of these are easily identified by the accompanying presence of a “guru” (i.e., a modern day miracle tonic peddler, who promises easy riches to the unwary in exchange for buying sponsored books or videos that detail his or her full-proof investing methods).  However, a couple bad real estate investment vehicles are more subtle:

Timeshares

Timeshares are something of a running joke in our country, and popular culture is chock-full of hilarious references to these dubious real estate investments.  Typically, an unassuming everyman/woman will receive an invitation to an expensive vacation spot (e.g., beach or ski resort) for free, with the stipulation that he/she attends a sales presentation regarding a local timeshare opportunity.  Once there, the vacationer continually tries to dodge the presentation, while timeshare salespeople use increasingly aggressive tactics until they finally make a sale.  But let’s enlist the help of our friends from Southpark to demonstrate timeshare salesmanship in action:

(Warning!  The following video clip contains mildly offensive language that may be unsuitable for children.)

The way it works is, people buy a vacation slot for a property (usually a condo), granting them “ownership” rights at a specific time of year.  Ownership passes to other investors for the rest of the year, and the only way to change your time-slot is to trade with someone else.  However, it is unlikely that you will be able to secure a more desirable slot, as sub-prime dates (e.g., the dead of winter for a beach timeshare) are usually what people are willing to trade!

Financially speaking, investing in a timeshare doesn’t make a whole lot of sense.  When you buy one, you must also pay for the timeshare developer’s cut of the profits, as well as the salesperson’s commission, administrative charges and ongoing maintenance fees to boot!  These costs translate into preposterously high mark-ups.

For example, if a standard beach bungalow is selling for $300,000 in Vacation Spot X, then the total cost of ownership for that property comes down to about $822 per day ($300,000 / 365 days = approx. $822), or $5,754 per week.  But you can expect a comparable timeshare property to be much more pricey (due to the high mark-ups), so that the cost of ownership for the same amount of time could easily be double.  To put that in perspective, you would end up paying $11,508 for the right to stay in the beach bungalow I just mentioned for one week out of the year.  If you multiply that amount by fifty-two (the number of weeks in a year), you can see that purchasing the timeshare for one week is the equivalent of paying twice the property’s fair market value ($11,508 x 52 = $598,416)!

Like puppy mills, ‘twirking’, Spam and the atomic bomb, timeshares are a stain on the record of human inventiveness.  It is sad that even respected companies have elected to fleece people by offering these lousy investments (e.g., Disney, Hilton, Marriott).  But for as long as timeshares continue to be profitable for the issuing companies, they are unlikely to disappear.

Limited Partnerships (LPs)

A typical general partner — i.e., 'fat cat' — for an LP
A typical general partner — i.e., ‘fat cat’ — for an LP

Limited partnerships (LPs) are venture capitalist groups that pool their money together for the purpose of investing it in new companies that (they think) are poised to excel.  At first glance, LPs appear similar to mutual funds, which are excellent financial vehicles — i.e., People buy into an LP just as they would when purchasing shares for a mutual fund, and profits earned as a result of the LP managers’ (called “general partners”) investment decisions are dispersed among the members.  However, as with most things, the devil is in the details:

First of all, you usually need a lot of cash to join an LP (e.g., a million dollars is a common requirement), and once in you assume the mantle of junior member (or “limited partner”).  Limited partners pay higher fees for the privilege of belonging to the group, and earn a smaller slice of the profits as a result.  To draw an analogy, imagine a high school cafeteria where students may pay for the privilege of sitting with the “cool kids,” by forking over a percentage of their lunches in exchange!

Limited partners can expect 20% – 25% of their initial buy-in to go towards lining the pockets of the general partners, which means that the LP must earn at least that much of a return for investors to break even!  Considering that the real estate market has shown an average rate of appreciation of about eight percent over the last thirty years, that’s a pretty tall order!  An infinitely more profitable alternative to joining a real estate oriented LP is to buy shares in a good REIT mutual fund instead.

<–[PREVIOUS] Part 3 of Residential and Commercial Real Estate Investing 101: ‘Real Estate Valuation & Cash Flow Analysis’

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Photo Credits

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  1. ‘Negotiating a successful real estate deal’. Source: ‘Resolve’ by dhendrix73,CC-BY-ND 2.0, via Flickr. 2012 Jan 5 [cited 2014 Mar 9]. Available from: http://www.flickr.com/photos/dhendrix/6644037141/
  2. ‘Donald Trump is known almost as well for his ludicrous hair as for his vast wealth!’ Source: ‘Donald Trump speaking at CPAC in Washington D.C. on February 10, 2011.’ by Gage SkidmoreCC-BY-SA 2.0, via Flickr. [cited 2014 Mar 9]. Available from: http://www.flickr.com/photos/gageskidmore/5440390625/
  3. ‘The Charlatan’. Source: ‘Der Scharlatan’ by Pietro Longhi (1702–1785), Public Domain, via Wikimedia Commons. Circa 1757 [cited 2014 Mar 9]. Available from: http://en.wikipedia.org/wiki/File:Pietro_Longhi_015.jpg
  4. “A typical general partner — i.e., ‘fat cat’ — for an LP”. Source: ‘Rich Man Person Suit Chair Sitting Gentleman’ by OpenClips, Public Domain, via Pixabay. Available from: http://pixabay.com/en/rich-man-person-suit-chair-146956/
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