Learn from My Mistake: Why You MUST Understand Your Seller’s Needs
Several weeks ago, I wrote an article about a deal I had to give up on because the bank wasn’t playing ball — it was called “Swing and a Miss.”
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The gist of that story is that I was trying to duplicate my deal of the year from 2011 in 2012 by buying the apartment build next door to my original 2011 purchase. In the story, I had to give up because I wasn’t able to structure the deal in the same fashion.
Shortly after I wrote that article, I had an epiphany. Why am I being so rigid and trying to structure the deal that worked for one bank, with a second bank? The properties may have been identical, but the situations were very different.
Once I realized I was making a tremendous mistake, I reengaged and started new negotiations with the second bank.
For your reference, I will highlight the key differences in the deals:
In the original deal, the property was vacant and needed $50K minimum worth of work to put it back into working order. The second property had a few vacant units, but it was producing income and had at least five paying tenants.
In the original deal, the seller knew they had to bring money to the table to close, pay real estate agent fees, and pay any real estate taxes due. In the second deal, the owner wanted a short sale and they were not willing to bring any money to close. They had not paid taxes in 18 months, and they had no money or interest in pay real estate commission.
Now for the similarities:
Both properties were 10 units, single story, with a courtyard in the center. In both cases, I was able to negotiate with the bank that had the troubled loan. In addition both banks were interested in making a deal work, but it had to be on their terms.
Once I acknowledged the differences and stopped focusing on the similarities, the negotiations were actually pretty easy. This is how the deal specifics broke down.
Price: The purchase price was never in question, as I established the price point by buying the property next door. However, remember that the property next door was a wreck and the second purchase was already producing income. But again the price was never in question.
Down Payment: In the original deal I was able to secure a zero down deal and the bank financed the entire purchase price. When I sat back and looked at the two deals, I realized why this worked once and not the second time.
In the first deal, the seller brought about 15K to closing, and thus the bank didn’t have to cough up any real cash to do the deal. For the original bank the down payment wasn’t important but selecting a buyer with a track record and proven reserves was critical.
As for the second deal, the bank wanted the same thing, but remember their seller was not going to bring any cash to close the deal. Thus, their preferred new buyer had to bring something to cover the short fall. Once I realized this fact, I quickly changed my offer to 10% down, which they quickly agreed to as it would cover most if not all of the short fall.
This proved important for both parties because the bank now had enough cash to pay all the fees, taxes, etc. Once we agreed on 10% down the bank was thrilled to establish a commercial loan, without having us bring in the traditional 30% down payment as they knew they had a problem loan on the books.
Interest Rate: In the original deal, since I wasn’t bringing any cash to the table, I gladly accepted their best rate of 7% interest. In the new deal, since I was required to bring an actual down payment, I negotiated hard and secured a 6% interest.
In addition, I secured the first 9 months at 6% interest only while I turn the building around and secure full occupancy. After 9 months, the loan automatically recasts (assuming I pay on time during the 9 months) as a 6% fully amortized commercial loan payable of 25 years with a 5 year fixed rate.
Extra Security: In both cases the banks wanted extra security given that they were establishing nontraditional commercial loans with a buyer they had no past experience with.
The original bank was most concerned with receiving their mortgage payments while I turned the building around. They foresaw a lot of work to be done and were afraid my cash would be tied up in repairs and they wouldn’t get paid. In this case, I simply agreed to open an account at their bank, where I placed 18 months of mortgage payments that they were able to auto-deduct on the first of each month. This assured the bank they had 18 months of payment, and given they were in town, they could drive by to see the rapid pace of repairs.
The second bank was concerned with the building continuing to decrease in quality. The bank knew there were roof issues and lots of deferred maintenance, as the seller had done nothing for at least 12 months. In this case, the bank wasn’t interested in securing a defined period of payment, but they wanted to escrow repair budgets. We agreed on putting 28K in an escrow account and we agreed to repair the roof inside of the first 90 days.
In the end, I was able to secure another distressed apartment building by understanding the needs of the bank holding the original loan. I was wrong and arrogant when I tried to repeat the structure of my first deal, simply because the building were the same. It wasn't until I realized that while the buildings are the same, the situations were completely different, that I was able to put a deal together.
Learn from my mistake!
You create winning deal structures by understanding the situation of the seller (or the bank in the case of a short sale).