Wednesday, February 28, 2024
Every investor knows the importance of doing due diligence before purchasing a property. But do you know the advanced methods to find deals consistently?
You’ve heard it over and over - make sure a deal works on paper before doing a deeper dive. This advice is exactly right. Things like your ARV, location, acquisition price, and financing all have to work before spending any more time researching a deal.
But once you’ve done that, what’s your next move?
You work to get the deal at a lower price.
Easier said than done, I know.
These days, with the popularity of real estate investing, sellers have begun over-valuing their properties because they know investors want them. Plus, you’ve got to move quickly to make an offer. This presents a problem when you’re looking for leverage in a negotiation. You can’t wait on a contractor to give you a bid, but you need a good understanding of the condition of the property to know what it’s worth. To solve this problem, you need a checklist of items you can quickly spot before speaking with a seller, a checklist of “scary” items, things you can use to make the property look less valuable than it actually is. Fortunately, most of these things can be found just by looking at photos from the MLS or your wholesaler.
Whenever you’re buying a property, you’ve got two choices. You can either pay full price for an over-valued property or you can use these items as leverage to get the price where it actually should be. Or at the very least understand that your “too good to be true” deal was not so good after all.
There are three main points of leverage to look for:
The Triple Threat, as the name implies, is made up of three items that could indicate deeper problems.
Things like signs of bleeding, structural damage, and DIY work will often be visible in photos or during a walkthrough. The issue, however, is that what you see on the surface isn’t always the full picture. You’re going to have to take what evidence you do have and make decisions based on that.
Time to put on your detective hat. Here are the three things I look for:
What’s the first thing you do when you cut your hand?
You apply pressure to stop the bleeding.
After all, your body can only take so much blood loss. Houses bleed too, however, the blood comes in different forms, like water intrusion, bug nesting, and fungal growth. Photos or a walkthrough may reveal that pressure has already been applied to stop various forms of house bleeding. But remember, blood leaves behind stains.
Some stains are noticeable: siding that has been eaten up, tracks in wood from termites, efflorescence on the foundation, or the smell of mildew. Other stains, however, are hidden inside the walls, under the floors, or even under the ground.
Be prepared to see signs of bleeding once you begin your renovation if you have spotted some of these clues.
When I see these signs there are a few things I look for to find the root of the problem.
Sure signs of potential structural damage come in the form of leaning walls, cracked drywall, sloping floors, crumbling foundations, etc.
If you see these signs at a property you’re considering buying, ask yourself these questions:
If the answer to all three of these questions is “yes,” you have a pretty big problem on your hands.
On the other hand, if you answered “no” to any of these, you may be dealing with something that looks far worse than it actually is. Use this to your advantage while negotiating your purchase price.
Let’s use an example to help. You have some sloping floors in a house that was caused by negative drainage to the house causing the foundation to sink on one side of the house.
After all, the worse something looks, the more it can “cost” to repair. But since you’ve been consuming all of our content, you’ll know how to get it done for a more reasonable price.
This may be the worst of the Triple Threat - buying from a homeowner who thinks they know how to be a contractor.
I’m not talking about someone who did a crappy paint job or some ugly trim work. I’m talking about the one who thinks they know how to frame, wire, plumb, etc. You never know what you’re going to find when you open up those walls. If you notice ANY signs of the “pro DIYer,” immediately increase your renovation budget. At this point, I’ve basically seen everything that nature and a bad tenant can do to a house. But I’m still constantly surprised by the creativity AND misguidance from a motivated DIYer.
The problem with The Triple Threat is that you can never see the full extent of the issues.
You have to collect clues and piece together as much of the puzzle as you can, building a story for your seller as to why you need a lower price for the property.
There are a handful of items to consider that may not end up on your budget as specific line items, but can cause contractors to raise their prices when giving bids.
We refer to these items as The Mirage because your seller isn’t going to notice these things. It’s up to you to bring them to his or her attention in your negotiation.
Is the power still on? Do you know how long it’s been off?
This is an indicator of how recently the home has been lived in. For the most part, when a house has been recently lived-in, you can assume things are working properly. It’s rare to find someone who will live in a house without electricity, modern plumbing, and HVAC.
I have seen people live in some pretty shabby conditions, but recent inhabitants are a good sign.
After The price your seller wants is based on his or her understanding of the property’s condition as it currently is.
He or she looks around and thinks, “This house is pretty close to being liveable. It’s not going to take much work to finish this thing.” But what if you know the property needs an extensive demo?
Demo is work that takes you in the opposite direction of “livable,” and it’s a two-fold hit.
First, you spend extra time and money stripping down the house - you know, actually doing the demo.
Then, you spend more time and money building the house to get back to where you started. A seller isn’t going to account for this extra time and money in his or her price. Make sure you account for that as you make your buying decisions.
If you’re looking at a deal that needs an extensive demo, make sure you use this leverage in your negotiations.
The more contractors you have to manage on a project, the more your bandwidth will be taken up and, more than likely, you will pay more to complete the project. The best way to counter this is by utilizing cost efficiencies.
Here’s an example:
The $7000 cost is the same, but are these projects equal in scope? No!
In House A, all of these jobs can be done by the same contractor - a carpenter. In House B, you’ll need three separate contractors. Getting House A to the finish line is going to require way less of your time because you’ll only need to manage one contractor instead of three, and because you gave one single carpenter all of that work, you likely got a better price.
Once again, all projects don’t always play out in reality like it seems like they will on paper.
When “EPA type” items like mold remediation, asbestos, lead paint, etc., or “scary jobs” like sewer line replacement, structural issues, etc. pop up, you need to take a second look to find out what you’re dealing with. There’s a lot of mystery around these types of jobs, unlike something more common, like painting or flooring, which most people basically understand. The market for these types of jobs are much smaller due to the complexity of the work, and inspectors tend to scrutinize these types of jobs more thoroughly. This usually leads to what I call a “fear tax” when you get a bid for any of these jobs.
If you think you might be facing a potential “fear tax,” be proactive. Use the possibility of a “scary job” in your sales pitch to explain why you need a better price for the house.
If you wait until your renovation, it’s too late.
You’re not always going to have the luxury of discovering everything wrong with a house before you buy it.
There are, however, some items that are obvious levers in negotiation, but hard to fully assess quickly for any issues. We refer to these items as The Big 6, the biggest ticket items on a normal-sized house with a normal-grade renovation. If you’re fortunate, you’ll be able to test these things yourself before pulling the trigger on your deal.
Either way, ask yourself the following questions as you look for obvious signs of necessary repair or replacement. Unlike the rest of this list, most sellers are familiar with these items, so you’ll need to be very clear on why these things are problematic, even if everything “works” properly.
1. Structural, also part of The Triple Threat
2. Roof
3. HVAC
4. Plumbing
5. Electrical
6. Windows/Siding
To be clear, a comprehensive scope of work and renovation budget will have more jobs and tasks than The Big 6. Even if you skip some of those other items in favor of The Big 6 (and add in some contingency dollars to your overall budget), you will keep yourself out of major trouble.
And if you really want to go a step further, consider doing some estimates on your own by adding a price per square foot or unit cost to each of the following typical items on a project. Do some research to get averages in your area. The calculation would only take you a few moments.
Incomplete? Yes. But it’s a helpful way to get some quick numbers in a pinch.
Note: We have all of these “jobs” in our Jobs Menu, which we’ve linked here. And P.S., we are working on an application that will allow you to do these calculations quickly, thoroughly, and on the go. If we’ve completed it, it will also be linked. If not, we either failed or are not done yet.
The next time you think you’ve got a great deal on your hands, do yourself a favor and refer to this guide and checklist as you work through your due diligence. As you go over photos or walk through a property, consider the items in the Triple Threat, Mirage, and Big 6.
Look for potential surprises and anything else the seller may have missed, and use what you find as leverage in your negotiation. Point out all the “scary” items and other flaws in the property. Explain to your seller how the things he or she can’t see actually impact the value of the house. And make sure they understand that things can “work properly” and still need to be repaired or even replaced.
Remember, you’ve only got two choices when buying a property, either pay the price set by the seller or pay the price you set via negotiation.
I prefer doing the latter.
If you liked this content, you know what to do.
Good luck out there investors.
CEO Of Larossa
After flipping over 300 houses, holding a portfolio of 150 properties, and creating a successful construction company for over a decade, I felt compelled to pay it forward by sharing the wealth of knowledge and experience I’ve accumulated on my journey.
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