Are you wondering at what point in the process of evaluating apartment building deals you make an offer and what that looks like? It might seem a bit of a mystery, but let’s shed some light on the matter.
What exactly does it mean to “make an offer”? Is it verbal or does it have to be written? If written, could it be an email, or does it need to be something more formal like a purchase contract?
The short answer is: all of the above.
Making offers on houses is a fairly well-defined event: it’s the point at which you send a purchase contract to the broker or seller. With commercial real estate, it’s a more interactive and prolonged process, starting with a series of “informal” offers that precede the more formal purchase contract.
Here’s the step-by-step guide to making offers on apartment buildings.
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4 Steps to Making Offers on Apartment Buildings
Step #1: Provide Initial Feedback to the Broker
When a deal initially comes in from your broker, your goal is to provide the broker with feedback as quickly as possible. You need to answer the question, “What is the most I am willing to pay for this deal and why?”
Why is this important?
Brokers have told me that only 25% of people on their list respond to a deal. By you responding with feedback, you are suddenly in that broker’s top 25% of buyers, which means you’ll be taken more seriously — VERY important, especially if you’re just starting out.
The second reason this is important is that this initial feedback actually starts the negotiation process.
Let’s say the asking price is $1.5M, but your initial 10-Minute Analysis is that the building is worth no more than $1.1M. You came to this conclusion because you felt you had to make two adjustments to the broker’s underwriting in the marketing package:
- The income in his underwriting was actually higher than what was in the rent roll provided; and
- The expenses were only 35% of the income, and you use 55% as a rule of thumb, which is both more realistic and conservative.
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This is the feedback you provide to the broker: “The property was advertised at a 8.5% cap rate. But the rent roll was actually lower than what was reported, and the expenses are only 35% of the income. I adjusted that to 55%, which is probably more realistic. Obviously, this reduces the Net Operating Income. In order to preserve the advertised cap rate of 8.5%, the value of the building is $1.1M, quite a bit lower than $1.5M. How set is the seller on that asking price? It seems a bit unrealistic, what do you think?”
There might be some discussion about your assumptions, etc., but this is a good dialogue to have with your broker or seller. The other thing you did is that you started the negotiation process.
Yup — you got it. You just “made an offer”!
If there’s a nibble, then you move on to Step # 2; otherwise, you just move on.
Step #2: Make a Series of Informal Offers
After the initial feedback, there might be some back and forth. Perhaps the broker will supply you with updated income and expense numbers. Maybe you visit the property and discover more repairs will be necessary than the broker initially told you.
Each time there is a revision of numbers from the additional information you are provided, you may have to adjust your informal offer price. You do this via emails, phone calls or in-person meetings. As long as the two parties are still talking, then you’re still in the game.
Step #3: Submit a Letter of Intent
Once your offer price moves into the “strike zone” of what the seller is looking for, the broker will tell you to submit your offer via a Letter of Intent (LOI).
The LOI is not legally binding, but it communicates the major points of the transaction: the offer price, the amount of down payment, and how long you’ll need to complete due diligence and to close.
Once you have the LOI signed, it’s time to move to Step #4.
Step #4: Submit a Formal Purchase Contract
No one wants to pay an attorney to draw up a formal purchase contract before the main terms of the transaction are agreed upon. The LOI is the document to do that. Once it’s signed, you (as the buyer) can ask your attorney to prepare the purchase contract.
Once the purchase contract is ratified, you are officially “under contract.”
As you can see, there are a series of steps in the “offer-making” process that begin informally at first and become more formal as you progress in the negotiation process.
But if you’re keeping track and have a quota to meet for making offers (which you should), providing that initial feedback to the broker after you first get the deal package counts!
What comments or questions do you have about the offer-making process? Any cool stories you can share?
Don’t forget to leave a comment!