7.3 The Negotiation

WEALTH AS A VACATION

bedroom for $10,000, bringing the earning potential of the home up from $40,000/year to $60,000/year. Accounting for the additional construction cost for the new room into the home price means investing a total of $550,000. But with the increased earning potential, the cap rate becomes 10.9 percent ($60,000/$550,000)—a nice jump.

If they are unable to negotiate, they will need to fi gure value beyond cap rate. For example, does owning beachfront property where they may someday retire make it worth it to buy a home with slightly lower earning potential on the rental market?

Knowing what a cap rate is and why it’s important will help you make a more informed decision when buying a vacation rental.

Cash-On-Cash Return Cash-on-cash return is a related metric that considers mortgage fi nancing. This metric compares cash fl ows, less fi nancing expenses, with the down payment. As cash-on-cash returns just consider the diff erence between the income and the mortgage against the down payment, they can be sensitive to variations in performance.

For example, for a property with a $600,000 purchase price, a $100,000 down payment, and a $1,800 monthly mortgage payment, the cash-on-cash return is only 2.4% when income after expenses is $24k in one year. It jumps to 20.4% when income after expenses is $42k. The diff erence in cap rate between those two examples? Only three percent.

7.3 The Negotiation

Now the fun begins! As my mentor in real estate once said, “Don’t fall in love with bricks and mortar.” This is great advice for your VRP business. You will see many existing vacation homes, and likely fall in love over and over. You will be immersed in beautiful renderings, aerial views, 3D walkthroughs, and have fi nished samples of countertops, fl oors, tile, and paint color set before you until you feel you might drown.

CHAPTER 7

Stop and take a breath. All of this is fi ne but you need to observe and not make judgments, on every little detail. Remember, your business and your future enjoyment depend upon your ability to maintain the balance between personal enrichment and fi nancial profi t. This will take some discipline as homes, certainly for me, take on their own life. I feel an empty home seems to be sad, for example. It’s a beautiful sentiment, but I put that thought away when analyzing potential VRP purchases.

Once you do fi nd a VRP that you think fi ts your needs and you want to buy, you may be ready to bid full asking price or even more to beat out any competitors out there. This is where emotions can sometimes outweigh logic, so before you jump in with an off er way above asking price, it’s good to take a moment to consider if the house is also a wise investment.

Even in today’s hot real estate market (in most parts of the country), it’s not often that a seller isn’t willing to negotiate . . . if not on the price, then on other matters such as the closing date, or including certain items like the barbecue grill, the washer and dryer, etc.

If you’re in a market that isn’t warm right now, you could end up being the only buyer making an off er. If that’s the case, there is a good chance you could end up buying for lower than the listing price. Your realtor should understand your market well enough to help guide your initial off er.

It’s not often that a seller puts his or her house on the market just to see what kind of off ers come in. Sellers generally want to sell, yet some sellers are more motivated. Perhaps they’ve already made an off er on another VRP, or their personal situation has changed. That’s why it’s a good idea to ask their agent why they’re selling. You may not get an answer, but it doesn’t hurt to ask.

Nothing is accomplished by going in with a low-ball off er (except sometimes in the cases of foreclosures or when a home is signifi cantly overpriced and has been on the market a long time). If you go in too low, you’re going to insult the seller. If your research shows that the property is fairly priced, or your trusted agent is telling you it is, make

WEALTH AS A VACATION

an off er you feel comfortable with and that your agent believes is reasonable.

If your off er does not elicit a meaningful counter-off er from the seller, you know you went in too low. So, try again. Once the seller believes you’re capable of arriving at a price that is agreeable to them, they’ll be willing to negotiate. If you can’t put together a deal on the fi rst property you like, don’t worry. There will be many more homes for sale. It is VERY common to lose out to another buyer in today’s market. But it’s just as common to end up fi nding a home a week or even a month later that you like even more than the fi rst. Not getting that fi rst home might be a blessing in disguise.

Today’s real estate market is really moving in a lot of areas, so the days of being coy about whether you like the house or not are over for now. In fact, in some markets, sellers are looking for off er letters along with your bid. They want to know your personal story to help them decide between multiple off ers. You want the buyer to know how much you love their home, but you don’t want to be overcome by emotions. You’ve done your homework. You know what the VRP values are in the area you’re searching, and you know how much vacation home you can aff ord, so don’t allow yourself to get boxed into a price that is above your comfort zone. If you have chosen your agent well, this won’t happen.

When you make your off er, there will be a space for putting a time limit on how long it’s valid. Make this a very short period, for example, 24 hours. Having a longer period just invites competing off ers.

If the seller seems emotionally tied to a certain price on the property, ask for certain concessions, such as repairs, instead of a lower price. The owner could contribute to the closing costs, or leave the washer and dryer, the patio furniture, etc. You can also negotiate after the home inspection. Ask the sellers for a cash-back credit at the close of escrow, which can help you complete needed improvement or repair projects yourself. You can also ask the seller for a credit to fi x certain issues in the interest of off setting closing costs.

CHAPTER 7

The Purchase Offer Your purchase off er is a written contract that you sign and submit to the seller. It is accompanied by a certain amount of earnest money, a small good faith deposit to show you are serious about buying the home. The written purchase off er indicates the amount you are willing to give the seller for his or her property. An experienced real estate agent will typically provide a standard purchase off er form you can complete, sign, and then hand over to the seller to sign. If you are not working with a realtor, be sure you are aware of state laws regarding the information the off er should include.

There are some important details you should be sure to talk through with your agent and make sure are accurately included on your purchase off er, such as:

• The amount you are off ering for the VRP • How you will pay the seller (cash, check, wired funds, etc.) • Contingencies to protect you if your fi nancing falls through, or if the inspection unearths major problems with the home (inspection happens after you make an off er) • Conveyances, such as whether the home will come furnished or unfurnished • An expiration date, by which the seller must respond before your off er expires • Concessions, such as any closing costs or other costs which you would like the seller to pay • The amount of earnest money you want to off er (often 1–2 percent of the off er price, though it can range from about $500 to 5% of the value of the home, depending on where you are interested in buying, and the state of the market). Your earnest money is typically put towards your closing costs; however, if you enter into a contract with the seller and then breach that contract, you could stand to lose this money. • The size of your down payment