The Seller’s “Bottom Price” Isn’t My Problem

Most of these properties are heavily discounted because they require extensive renovations.

I wrote about how this opportunity came about in a previous post, “When a $32B Real Estate Hedge Fund Calls Me.”

My first listing went live in February. Since then, I have listed multiple properties, and I knew there would be a two- to four-month ramp-up period before I started seeing closings.

We’re now at that point.

Several properties are already under contract, and I recently had my first closing. My commission was $4,025.

That may not sound like a huge number, but if I can consistently get two or three closings per month, it becomes a great revenue stream.

On one of the properties, I am also acting as the dual broker, representing both the buyer and seller. That requires me to make sure both parties are treated fairly, maintain the appropriate confidentiality, and work toward getting both sides to an agreement.

But there is one issue that keeps coming up during negotiations.

“That’s Our Bottom Price.”

On some of the lower offers, the hedge fund comes back with the same response:

“That’s our bottom price.”

I understand it.

Every seller has a number they don’t want to go below.

The problem is that the seller’s bottom price doesn’t necessarily have anything to do with what an investor can afford to pay.

If the buyer is an investor, the property has to make financial sense based on the numbers and the risk involved.

As an investor myself, I typically look at a property using a variation of the 70% rule:

70% of ARV − renovation costs = maximum purchase price.

It’s not a perfect formula, and every investor has different financing, holding costs, profit requirements and risk tolerance. But it provides a useful starting point.

After all, once I buy the property, I assume all of the risk.

The property’s value today may be very different from its value four to six months from now when the renovation is complete.

Here’s a Real Example

One of the properties I’m selling has an estimated retail value, or ARV, of approximately $280,000.

I listed it for $155,000.

An identical house next door, which had been renovated by another investor, went under contract after only two days on the market and sold for $280,000.

At first glance, this looks like an incredible opportunity.

The property is listed at only about 55% of its potential retail value.

But there’s a problem.

The house needs approximately $75,000 or more in renovations.

There are structural issues, water intrusion, mold, a bad roof and numerous other problems.

On the positive side, it’s a four-bedroom, two-bathroom house with a two-car garage, sits on top of a mountain with incredible views, and is located in a desirable neighborhood.

So let’s run the numbers.

$280,000 ARV

× 70% = $196,000

− $75,000 estimated renovations

= $121,000 maximum purchase price

Based on those assumptions, approximately $121,000 would be my maximum purchase price.

That doesn’t mean the property is only worth $121,000.

It means $121,000 is roughly where the numbers begin to make sense for an investor taking on this particular project.

But What About the $84,000 Spread?

At a $121,000 purchase price, the difference between the purchase price and the 70% ARV threshold is approximately $75,000 after accounting for the renovation budget.

It may initially look like there is plenty of room for profit.

There isn’t.

The investor still has to pay closing costs when buying and seller, financing costs, commissions, insurance, utilities, property taxes, interest and other holding expenses (e.g. hard money).

And on a project of this size, there will almost certainly be unexpected expenses.

Anyone who has renovated houses knows the renovation budget rarely ends up being exactly what you originally estimated.

You open a wall and find something you didn’t expect.

You discover additional water damage.

The structural repairs cost more than anticipated.

The roof requires more work.

The electrical system needs upgrading.

One problem leads to another.

That’s the risk the investor is taking.

For a project this complicated, I would want to make at least $50,000 in net profit to justify taking on the risk.

That leaves approximately $34,000 as a cushion for additional expenses, financing costs and other surprises.

And that cushion can disappear quickly.

The Problem With the Seller’s Bottom Price

Right now, the hedge fund’s bottom price is $135,000, while the buyer has offered $125,000.

The difference is only $10,000.

But the seller doesn’t want to take the $10,000 hit.

I’ve explained the property’s condition and renovation costs multiple times.

The buyer even provided the inspection report he paid for to the seller as additional evidence of the property’s condition.

Still, the seller’s position remains the same:

$135,000 is the bottom price.

And this is where I believe many sellers misunderstand the investor’s perspective.

The Seller’s Bottom Price Isn’t My Problem

When a seller tells me, “I need $135,000,” they’re telling me what they want.

They aren’t necessarily telling me what the property is worth to me.

Those are two completely different things.

Maybe the seller purchased the property for $100,000 five years ago.

Maybe they owe $135,000 on the mortgage.

Maybe they need $135,000 to accomplish whatever financial objective they have.

None of those numbers determine what an investor can afford to pay.

The investor has to look at the property based on its future value, renovation costs, financing, holding costs, selling expenses, risk and required profit.

The seller’s financial situation doesn’t change those numbers.

Investors Don’t Buy Equity. They Buy Risk.

This is an important distinction.

The investor has to spend money to unlock that equity.

They have to put up capital, borrow money, manage contractors, deal with inspections, handle unexpected repairs and wait months before they know whether their projections were correct.

And there is no guarantee the finished property will sell for the projected ARV.

That’s why an investor’s offer may look low to a seller who is only looking at the property’s potential value.

The investor isn’t buying the potential.

They’re buying the risk required to create the potential.

A Better Way to Negotiate With Investors

If I’m representing a seller, my job isn’t to convince an investor to pay more simply because the seller wants more.

My job is to find the price where the deal makes sense for both parties.

If the investor’s maximum number is $125,000 and the seller’s bottom price is $135,000, there is a $10,000 gap.

Sometimes that gap can be overcome through better terms,  a quick closing date, or other creative structures.

But if the underlying economics don’t work, no amount of negotiating changes the math.

That’s the lesson sellers need to understand.

A Proven Strategy: Work Backward From the Investor’s Numbers

When I’m evaluating a distressed property, I don’t start with the seller’s asking price.

I start with the finished value and work backward.

I estimate the realistic ARV, calculate the renovation costs, account for financing and holding expenses, factor in selling costs, and then determine the profit I need to justify the risk.

That produces my maximum purchase price.

I don’t negotiate upward from my maximum. I negotiate downward from the numbers and that is what I teach other investors.

If the seller can meet that number, we have a deal.

If they can’t, the property may simply be worth more to someone else than it is to me like with the current buyer of this property for example.

And that’s okay.

The goal isn’t to buy every property.

The goal is to buy the right properties at prices that leave enough room for profit, unexpected expenses and the risk I or a fellow investor is taking.

And the final outcome of the current offer at $125,000? We will know in the coming days and I shall keep you posted.