Inevitably I have students tell me they are fearful of overbidding on a property because they think they will bleed to death trying to find a buyer. This is a very viable concern unless you know the different ways to handle the various solutions to this potential problem.
This issue usually occurs because the investor is so eager to get a deal he listens to the seller’s sales pitch or doesn’t do a proper evaluation of the property. Simply getting a Broker’s Price Opinion (BPO) or a Comparative Market Analysis (CMA) from a realtor® does not mean that is the value of the property. Even an appraisal can be misleading if it is optimistic by using older comparable sales or sales that are in a similar but not in the same neighborhood.
Let’s look at the various options an investor has to make it safer to make an offer and not be fearful that he will lose his deposit or buy an over-valued property:
1. Before deciding on what offer to make, safeguard yourself with the longest inspection period possible on your Purchase Contract. I prefer 10 days for REOs (bank-owned properties – most will be 5 to 7 days), 15 days for short sales (inspection period must start after lender approval) and for homeowners at least 21 days and preferably longer (longest we have had was 6 months!).
Your inspection period is your protection for the possible scenario that you offered too much and then realized it before the closing. This way you are protected up until the end of the inspection period from getting stuck in the property and “bleeding money”.
2. Your second “at risk” asset is your Earnest Money Deposit (EMD). Some sellers want 10% or more but, generally, I always offer $100 to homeowners, $250 – $500 for short sales and $1,000 for REOs unless they are required to have 10% down, i.e.; Federal National Mortgage Association (FNMA).
To combat the issue of the seller wanting a large deposit, I offer to give the EMD in two parts – a minimal first payment with the contract of 10% to 20% of the total deposit I will have up if I go past the inspection period. For example, seller wants $10,000 deposit on a $150,000 priced property. I would offer $1,000 with the original signed contract and $9,000 when the inspection period is over.
The “safety net” for not losing this EMD is to get an equal or larger EMD from your end-buyer if you are wholesaling the property. If the end-buyer defaults, he loses his deposit and if you don’t close so do you. However, for you it is a wash and you may even make money on his EMD if yours was smaller with the original seller.
3. Try wholesaling the property during the inspection period because you may get a buyer who believes it is worth more than you think – take the profit if you are not absolutely sure you can make money on it after you close on it.
4. Don’t use the highest closed comparable sales as a guideline for what you believe it can be sold for – use the median closed comparable price in the neighborhood – this alone will keep you out of pricing trouble if you follow this guideline.
The difference can be 20% to 30% higher than the median value or more. The price you can actually get when you sell your rehab is more a function of getting a solid buyer who has cash or who can get financing and is at the same time a motivated buyer.
Let’s assume you have used the “fail safes” above – first, properly contracting to get you out during the inspection or a clause in your contract that states, “Contract subject to Buyer’s partner’s approval before closing.”, lowest possible EMD and you try to find wholesale buyers while all the time using median comparables to price your offer – but you still paid too much.
Now is the time to make a pure business decision instead of an emotional one. Taking a loss on a property is not the end of the world, you will take losses the more successful you become – it is a fact of life. If you never have a loss, you are missing many times the number of deals you are completing! Use these safeguards and start making offers and you find that being afraid of over-bidding really doesn’t matter!
To your limitless success,