Trying to Buy Real Estate Below Market

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This question:


What real estate office can I trust to help buy below market house in (location) California?

brought someone to the site and I have not previously written a real answer to the question.


The short answer is "nobody."

This doesn't have to do with trust. It has to do with the facts of life and bad assumptions.

What is the definition of market price? It is the price at which a willing buyer and a willing seller exchange a property. In other words, what you buy it for is by definition the market price.

Everybody wants to buy real estate for less than it's really worth, just like everyone wants to sell it for more than it's really worth. Mathematically speaking, at least fifty percent of each have to fail, and the fact that you're even asking the question indicates that you have made incorrect assumptions.

Real Estate is not like stocks or bonds. No matter how big or how small your transaction, it's always a "one of a kind" transaction. Every property situation is unique. If you are selling, you need to find one buyer willing and able to buy that property for a price you are willing to sell. If you are buying, you need to find one property attractive to you where the owner is willing to sell at a price you are willing and able to buy it at.

This is not to say that the general market is irrelevant. If someone is pricing a more desirable home lower than you, you've overpriced your property. If the identical condo next door to the one you bought sold for ten percent less, you probably overpaid. But it's not for nothing that the mantra about the three most important things in real estate being "location, location, and location." No two properties are ever identical. Think condos, even. Which would you rather have: The one right next to the parking lot, the mailboxes, and the swimming pool, or the one way in the back where you have to walk a quarter mile from your car, and further from everything else but have no disturbances? I assure you that a goodly portion of the population would choose the one you think of as less attractive. It's the choice of the individual buyer, and a real estate agent has to learn how to get the attention of the person who's most likely to be interested in that property.

I keep telling people that getting a good price at sale time is nice for both the buyer and the seller, but the really important thing for the quality of investment is your amount of time in the investment. Let's go back a few years. Homes in my neighborhood were worth maybe $180,000 at the time, and condos were worth maybe $65,000. Had people going around making low ball offers on everything. Offered maybe $55,000 for the condos, $150,000 for the homes. Nobody who wasn't desperate wanted to sell, of course, and that's just what they were checking for - desperation. Had they offered something vaguely reasonable, say $60,000 for the condos or $170,000 for the detached homes, they likely would have gotten a property. At least one group of these people ended up not buying anything. Fast forward five years. Those same condos were worth $275,000, and those same homes were selling for $500,000. If the thought of missing out on $210,000 profit for the condos because you couldn't make $217,000 bothers you, then you seem pretty rational to me. If, on the other hand, the thought of missing out on an extra $20,000 you're not going to get for the single family residence makes you want to just throw $330,000 base profit (tripling your money!) out the window, please go waste someone else's time.

This update allows me to make yet another point: those same properties are now selling for $150,000 for the condos and $380,000 for the detached homes. What's the difference? There are two actually. One is inventory. More people want to sell now, fewer people are willing and able to buy. The second is the loan environment controls the real estate market. When anyone with a pulse can get 100% financing, prices rise quickly because it's not real money to those buyers. When it's difficult to qualify for a loan, as it is right now, that holds the prices down. As a reaction to loan investor losses (aka closing barn door and adding five more after horse has already escaped), it's more difficult to qualify for a loan right now than any time since I have been an adult - thirty plus years. What happens to market prices when loan restrictions start easing back to some happier medium, as they will?

There is nothing wrong with desperation sales and offers that are desperation checks, so long as you are willing and able to then proceed to something more reasonable, or just as happy to move on. Nobody wants to sell to somebody looking to flip a property, but they do want to sell for a reasonable price. That's why the property is on the market. Somebody offers me (or my client) fifteen percent less than comparable market sales, I usually counsel my client to write something like "offer rejected. Why would I (my client) want to give you fifteen percent of my investment's value?" and append a list of comparable properties. Counter-offering just wastes time when the offer isn't even in the right ballpark. The ones who can come back with a reasonable offer want the property, or they wouldn't have made the offer. The ones just looking for the desperation sale aren't going to bother.

Now some potential buyers are only interested in desperation scenarios. I've got a couple clients like that. That's fine, but you're going to work awfully hard and put in a lot of offers before you get one, and the ones with the most potential for quick profit are going to be the ones where there is a lot of work to be done. Additionally, right now the market just won't support CondoFlippers Inc.

Yes, I believe in hard bargaining. Judging from evidence I see around me, I'm one of a small percentage who does. But I'm willing to come from a reasonable starting position. As I've said before, bargaining room is nothing. Bargaining strength is everything. I do love it, though, when my clients decide they want to put an offer in on a discount agent's listing, because the client I'm acting as buyer's agent for is going to think I walk on water when the transaction is over, while the sellers are going to find out first hand the truth of the adage "You get what you pay for".

Lest you think that your negotiation discount equals your profit, it isn't. It's a small part of your profit. Let's say you get the property for $250,000 or you won't buy it at all, even though comparables are selling for $275,000. Let's say you intend to flip for $290,000, not that that's going to happen in this market, but let's say you succeed anyway. Your net is something like $268,000, after spending $253,000 or so to buy, and you spent about $5000 making the payments on the mortgage even if it did sell right away (more likely, given the current realities, that you spend the entire "profit" on the mortgage payment!)

Now let's say, instead, that the market collapses twenty percent the day after you buy, down to $220,000. If you have a sustainable mortgage and bring in a tenant, your cash flow should be even or positive. Hold on to the darned thing for five years, and at historical seven percent average per year, the property is worth $308,000. Hold it ten years and it's worth $432,000 under the same assumptions. The first number gives you as much profit as the flipper even has a theoretical chance for, while the latter blows the flipper out of the water. Even after a price collapse, and because you've been in a sustainable situation this whole time, it really isn't critical how long the prices take to come back, because you're not under the gun of a deadline. So long as you have a sustainable cash flow, the risk is essentially nonexistent. It's when you have an unsustainable cash flow that you've got to worry. Say like, an empty unit where you've got to make the mortgage payment without rent because you're trying to flip it.

In fact, given a sustainable cash flow, unless property values collapse and stay down forever, the question is closer to when you're going to cash out and how much, rather than if. Southern California Real Estate has always moved in cycles. What's down today is up forty percent five years from now. The trick is being able to bridge the gap between now and then. Having the fortitude to buy when nobody else wants to, and sell when things are ripe for a fall, will make you more money than anything else.

If some of the above seems like I'm attacking the "bigger fool" theory of real estate, consider this: Somebody's always the last, biggest, fool in line, and until you find a buyer and consummate the sale, that person is you*. It should be an agent's responsibility to see to it that their clients aren't the only ones without a chair when the music stops. For all too many agents and loan officers, their thinking stops at the receipt of the commission check. I may not sell a house every day of the year, but my clients don't get foreclosed on. That isn't an accident.

Caveat Emptor

*- if you are buying a place to live, the bigger fool theory is limited in its application. You've got to have a place to live. If you never sell, it's not nearly as important what the property is worth. The only times the value of the property is important is when you sell or when you refinance.

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About this Entry

This page contains a single entry by Dan Melson published on September 1, 2014 7:00 AM.

Don't Let Cash Distract You From Cost In Real Estate was the previous entry in this blog.

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