In the initial part of this series I highlighted an opportunity to purchase a rundown apartment building. The owner had to foreclose on the private party who had purchased the building in 2005 and left the owner with a huge mess.
When structuring my creative deals the first thing I do is share with the agent and the seller that I have a 10 year track record with. I let it be known that I want to be rewarded for my efforts in turning the distressed assets into the best value for the rental dollar.
In this case I shared with the seller’s agent that I wanted to talk about a deal structure where the seller once again carried the first mortgage. I understood they had been burned by the previous buyer but if I was going to take on this headache, I needed to maximize the use of my cash to insure I had the runway to turn the building quickly. The seller didn’t rule it out but said they needed security as they were getting older and didn’t want a repeat of the past mistakes.
Next, I thought it was time to meet the seller at the building, as they had lived in So Cal for the past 5 years. They hadn’t seen the property and they only had a casual understanding of the problem that had been placed in their lap. I on the other hand had been to the property a couple of times by this point and I knew they would not be happy with what they found once they arrived.
One Saturday morning in early October we met at the property and went through 16 of the 18 units; the owner was shocked at how bad the building looked. I knew the seller was in shock when he drove up and said “Where is the grass?” The carports were falling down and that was the good part.
The interior inspections went from bad to worse. At one point we saw a unit with two small dogs who did their business inside the unit – wherever they wanted – and no one had picked it up for weeks. The crazy part was this wasn’t even near the worst unit — think about that!!!
After our 90 minute review of the property, we went to have lunch as it was clear he wanted to sell and I wanted to buy, so we had to negotiate a win-win deal. He started the negotiation. He said he was owed over 800K on the original note and that there were significant back taxes requiring payment to have clear title.
I let him know that in the current market and in the current condition that I thought the top end value for the building was 600K (tops). I told him a little more about us and the track record we have in turning around problem buildings from fully vacant to partially vacant buildings. During the conversation I let it be known that when the seller worked with us, I have been known to pay more than I thought the building was worth if I got my terms.
The comment about paying more than I thought a building was worth really got his attention, so he asked me to explain what I meant. With this opening, I explained that my most important metric is investment yield, and that if I could control my cash down payment and my monthly mortgage payment, that I could pay more than 600K. I also let him know that I thought the building could need up to 80K to turn around in the next 6-9 months.
He really liked the idea that I was planning such a large expense for improving the building so he asked me for a proposal. I hadn’t run any numbers yet but I presented the following, knowing I could make it work. I offered 700K (fully 100K more than the building was worth) if the owner would accept “$0” down and carry back the 700K note at 5% interest only for 10 years.
The owner was both happy and frustrated at the same time. The seller said that this was 100K less than the original note, it was a lower interest rate and that in this case, he would be responsible for bringing cash to the table to close (pay commission and back taxes).
I agreed and sympathized. I let them know that the back taxes weren’t on me and that he should pay them immediately, as they accrue at 1.5% interest compounded monthly when they are 2+ years late (this was news to him). Then I let him know that while I appreciated the need for cash to close, that I needed cash to repair the building. I also told him that I would be happy to buy the building for 800K after he turned the building around in a year.
The last thing I offered was that if he needed cash at closing that I could prepay mortgage payments at the close if required, but I preferred not to. This is when the deal crystallized. The seller let it be known that he didn’t need the cash, and that removing the problem with someone he trusted was more important to him.
He wanted to think about it but he felt we could work something out that met both our needs. After several more conversations we agreed to the basic structure above with one small tweak – I had to provide the seller with additional security that he didn’t have in the first deal.
First, I committed to sending pictures of the work as it progressed; second I allowed for yearly inspections at the sellers discretion and then I offered security in another small property I owned free and clear. This last piece would be automatically removed after three years of on time payments. With this final piece we had a deal with Zero down.
The key to part two was communicating, listening and negotiating for a win-win situations. That leaves part three – where the real work begins.