Negotiating the foreclosure market
During the last 13 years, “Buy Low, Rent Smart, Sell High” co-authors Scott Frank and Andy Heller have been investment partners buying foreclosed houses from lenders, fixing and renting them, and then selling to their lease-purchase tenants. But this is just part-time work for the partners who work full time as executives for large corporations.
Together, they have bought and sold more than $10 million of residential property. Their modus operandi is to buy bargain-priced foreclosures in middle-income neighborhoods after the lender has taken the property back from a defaulting owner. They dislike buying direct from defaulting owners because of the seller emotions involved.
They prefer buying from lenders because it’s a purely business transaction and lenders often become highly motivated to get the foreclosed property off their books, even at a bargain price.
Frank and Heller explain how they arrive at their offer prices. Their starting point is the house’s market value if it were in good condition. From that valuation they subtract a 15% “investor discount.” That means they earn their first profit at the time of purchase. Next, they subtract the repair and improvement costs, closing costs, finance costs, taxes and insurance during the holding period, marketing expenses, utilities and mortgage payment expenses.
The result is the maximum “ceiling price” the authors will pay. But their initial purchase offer is usually 10% to 25% less, allowing room for negotiation. Each offer is accompanied by a one-page cover letter to explain how the buyers arrived at their price. Frank and Heller explain they don’t want to be known as “lowballers,” but their first offers are usually rejected.
But they keep coming back a month or two later when the lender often becomes more motivated to sell. The authors emphasize the importance of building a solid reputation with lenders and REO (real estate owned) agents for performing as agreed. They include inspection contingencies in their offers just in case the house has unexpected defects.
The authors fix up houses as quickly as possible, using small, low-overhead contractors with whom they have done business repeatedly, then offering the houses for rent on three-year lease-purchase contracts. They charge market rent but offer their tenants a 10% down payment rent credit to encourage purchase of the home within the three-year lease period.
The option purchase price is set at the home’s market value when the lease is signed and it remains fixed for the three-year term. The authors consider it unfair of some lease-purchase sellers to make the option subject to an appraisal at the time the tenant decides to buy. If home values skyrocket, Frank and Heller explain, the tenant benefits. Throughout the book are copies of the forms and contracts the authors use. Emphasis is placed on financing both the acquisitions and the improvements. The authors explain that investors should move slowly to minimize their financial risks.
