Commandment #9: Thou shalt not expect something for nothing.
“There is no such thing as a free lunch.” “If it looks too good to be true…, etc.”
You have heard these truisms many times. I’ve reserved a place of honor for them in my upcoming “Encyclopedia of Clichés.” Just because something is a well-worn bromide, however, doesn’t mean it isn’t true, and sometimes we can look right past its importance because we assume it should be obvious.
Our rational selves all recognize that virtually everything has a cost, even things that are free. “Call now for our free report about investing in gold! (or about mortgage modification or crabgrass prevention).” Translation: Give us your telephone number so we can hound you relentlessly until you buy something from us.
When a guy in a brightly colored checkered sport jacket tells you something is free or involves no obligation, you suspect immediately that you are being scammed. It is when the “great deal” is dressed up more subtly that you may miss what’s really at work.
I’ve seen such illusory great deals cloud the minds of investors, and I talk about this in my grad school classes in real estate investment analysis. One example that I use is the case of a seller who is providing extremely generous owner financing: very low rate with interest-only for an extended period. Should you assume that he’s doing this because he likes you? If not, then you ought to be looking for what element of self-interest is motivating him and whether or not you are paying for his generosity in some other way.
Perhaps the low initial debt service will improve your cash flow as a prospective new owner, and the seller expects that benefit to serve as a smoke screen of sorts, inducing you to look more kindly on what is actually an inflated purchase price. As a side benefit to him, maybe he is also thinking that he will shift some of his overall profit from what he would get by charging higher interest on the financing, taxed at ordinary income rates, to capital gain taxed (at least as I write this) at a lower rate.
In short, you need to look behind the “great deal” and work your way deeper into its implications for you as the investor. Will you really have an acceptable long-term return? If a life emergency forced you to re-sell this property soon, would a new buyer who requires financing on more conventional terms be willing to pay as much as you just did?
Or perhaps the deeper meaning in this example is simply that the owner is offering these terms because he really has to sell this building as quickly as possible. Can you use that insight to your advantage and negotiate to get the attractive financing as well as a lower price? Get the worm but not the hook?
Another example I use in my classes concerns a commercial property that has a vacancy in one of its six retail spaces. To offset your reluctance to buy, the seller makes this proposition: “I will guarantee the rent for that space for a full year at $x per square foot. Run your numbers and you will see that my asking price makes good sense and provides you with an excellent return.” (an aside: $x/sf is at the high end of reasonable rent for that space.)
It sounds good. Maybe too good, and that’s when your alarm bells need to clang. You pause for breath, think a bit harder, and then realize that another way of looking at this is that the seller has effectively offered you a price reduction equal to the amount of one year’s rent for that space. You need to ask yourself if that concession materially changes the risk associated with this deal. Does this disguised price reduction compensate you adequately for the risk you’re assuming? Can you eventually rent the space for $x dollars? Has there been a problem getting or keeping tenants in the past, either for this space or for the entire property? Is this proposition a creative solution to a temporary vacancy, or is the seller trying to kick the proverbial can down the road and leave you to figure out what to do about this property’s chronic vacancy?
The could be a creative solution to a short-term problem, or it could be smoke and mirrors to hide a long-term difficulty. If this offer is nothing more than a price reduction, then perhaps you would choose to forget about rent guarantees and prefer instead to negotiate your own idea of an appropriate lower price, one that is more in concert with the actual degree of risk you see in this property.
So what is the takeaway from our ninth and penultimate commandment? In real estate dealmaking, there is seldom, if ever, anything offered that doesn’t have a cost of some sort, or a string attached. Your job is to identify that cost, follow that string. It’s not necessarily the case that anything underhanded is going on, although there may be a fine line at times between smart negotiating and subterfuge; but, in any case, you need to look beyond the outward appearance of what’s being offered and try to discover the motive behind it.
Ulterior, or otherwise.
A Postscript – (Can a post have a postscript?)
Before you conclude that I am a jaundiced, suspicious, disagreeable curmudgeon (and despite the fact that your conclusion strays not far from the truth), let me suggest that perhaps not every open hand portends a slap in the face. In an industry that is predominantly a zero-sum game, there are still those who are willing to be helpful without sending an invoice. I am of course not talking about the snake-oil salesmen and pay-to-play mentors I complained of in Commandment #6, but rather about those experienced investors and other real estate professionals who will actually – and willingly – share some of their expertise.
Several times in my posts and newsletters I’ve mentioned the forums at BiggerPockets.com as an example of this sort of knowledge exchange done right. (FYI, I have no financial or other inside interest in BP. Just a fan.) It works because it’s essentially a non-commercialized, pay-it-forward culture. I’ll answer your question, and someone else with a different specialization will answer mine.
There is a cost – there is always a cost – but in this case I believe it’s simply the implied obligation to be helpful if you’ve been helped. Pretty low-impact in an industry otherwise infested with high-priced, low-value gurus. And maybe some meaningful business will percolate up from the bottom of all this socialization. Just don’t let Groucho Marx join. As he famously remarked, “I don’t care to belong to any club that will have me as a member.”
Come back soon for Commandment #10
Previously: Ten Commandments for Real Estate Investors: Commandment #8
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