SFREI #24: How to optimize your deal to squeeze out the most value possible
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In this episode, host Jeff continues a deep-dive into the topic of Opportunity Vision–the ability to not only see what a property already is, but more importantly to be able to see what the property COULD be. Once you see this vision for the greatest possible opportunity, what do you next? In this episode, Jeff teaches how to take this vision and optimize the deal to capture this opportunity–and ultimately, to squeeze the most value possible out of every possible deal!
References in this Episode
The Opportunity Vision Analyzer Worksheet: Free Download!
This is Jeff from The Thoughtful Real Estate Entrepreneur. Welcome to episode number 24 of Sleaze-Free Real Estate Investing, a show for those of us who never felt at home. In the We Buy Houses crowd. So in this show we take a stand against what we call the lowbrow approach. This is the mainstream guru seminar distressed seller approach that ends up giving real estate investors of slimy reputation. Instead, we discuss the strategies, tactics and philosophies that we call the thoughtful way. This is an enlightened approach to real estate entrepreneurship that focuses on constantly sharpening the sophisticated real estate entrepreneurs three most critical capabilities. Number one, seller relations skills number two deal architecture skills and number three, opportunity vision. When all three of these capabilities are successfully in motion, you can make an excellent living today and build long term wealth while creating value for everybody that you touch along the way. We’ve got show notes for today’s episode at www.thoughtfulre.com/e24. Please do yourself Do us a big favor right now by hitting the subscribe button in your podcast
app. And you’ll always know exactly when the next episode is available. And it also helps us spread the word by strengthening our ranking in the iTunes platform. Now in the last episode, we discussed the concept of opportunity vision. So if you haven’t listened to that yet, it would be helpful preface for today’s conversation in which we’re going to continue that discussion. So go back and listen to Episode 23. If you haven’t done so already
But as always, we’re going to hit a little bit of food for thought, because we are Thoughtful Real Estate Entrepreneurs after all, and that means we like to feed our minds with things to think about, and here’s what we’re thinking about today. Today’s Food for Thought is this idea that a decent plan executed well is better than a great plan, executed poorly. Now, this is simple advice and it’s not uncommon advice, but for some personality types like mine, for instance, it can be easier said than there is a, an assessment out there assessment tool called cold EKLB. And Colby is different than a Myers Briggs or a disc in the sense that it measures slightly different aspects of who you are. But one of the things that Colby measures is what they call your Quick Start a how quickly and immediately Are you likely to take action on a new idea, I have a very high quickstart score. I have other scores that are lower that kind of offset that, but I have a very high quickstart score. And that means I’m one of those people who loves to have a new idea and take immediate action. So I can fall into this trap personally, of having a lot of things going on. But executing each one of those in kind of a mediocre way. Maybe you can relate to that. Maybe you can’t we’re all different, but the idea is Still the same about a decent plan executed well, or a great plan, executed poorly. Ultimately, it’s about the idea versus the execution. And some people find one way more exciting than the other, I always find the idea more exciting than the execution. And in some ways, I feel like that’s what makes me an entrepreneur, because I have ideas and I want to take action on them and I make things happen. But it also comes with difficulties as well, because executing on a continued basis is also then really necessary. So I always personally find new ideas more exciting, and I want to learn things, I want to try more things. I want to start more new things. But it can lead to having a lot of half done or half committed things. There are other people of course, who get much more excited about executing than they do about coming up with new ideas. And to idea people like me, those those folks seem a little bit crazy. I just can’t relate to that myself, but I know that they exist and thank goodness that they exist because We have to have both in our world. And that brings me to this point, what is more important? Is it a great idea, or is a great execution? And ideally, of course, you have both. But at the end of the day, it’s execution that outweighs ideas.
And I truly believe that if you talk to just about any successful entrepreneur, they will support that notion as well, even if they wish that wasn’t the case. execution is what outweighs idea. So what does this mean for you listening to this podcast right now? Well, you may not feel like you have a perfect plan for your real estate endeavors. You may not feel like you’ve got the perfect angle on what you’re going to do or the perfect edge, or the exact strategy mapped out that you are certain is going to work it will create wins for you. You may feel like you want to keep learning and keep reading and keep listening until you have a perfect plan.
But I’ll tell you that it’s more important to simply get started because executing What you do is the most important thing and you can’t execute until you’ve gotten started.
It’s most important to get started and execute what you know how to do now. And if you execute Well, you can adjust your plan along the way, that’s not a problem. But a great plan. executed poorly will never work as well as you greatly executing your imperfect plan. So I encourage you to get started on whatever it is, that might be on your mind that you’re wanting to do, but you’re not yet doing because your execution is more important than the idea. That’s today’s food for thought. And with that, we’re moving on to the main course of today’s episode. And today’s topic is our continued discussion on the topic that I call opportunity vision.
So to recap, from the last episode one time, my own coach Greg said something that was very special Simple, but it really stuck with me. And I think about this all the time, he said, the average person sees what’s there.
But the entrepreneur sees what could be there. And this is now what I call opportunity vision. It’s seeing all the elements of what could be there in evaluating each of those elements to determine where the greatest opportunity lies.
So in the last episode, we went over three big categories of opportunity vision, and how to see the difference between what’s there now and what could be there.
And those three categories are, number one, a physical perspective of the property, which does often translates into the value of the property where you have a small house there, it could be a bigger house, you have a house there, it could be a skyscraper, physical transformations that does change the value of the property number two, was the income perspective. This property is Generating $1,000 a month now, with these changes, it could be generating $5,000 a month now, then that is the income perspective. And then the third one is a little bit different, a little bit more sophisticated, but it’s the financial structuring perspective. Here’s how the finance is structured now, or kind of what the default structure might be. But here’s how it could be structured in a way that is more advantageous. So again, go back and listen to Episode 23, if you haven’t yet, for a fuller dive into each of those three things, but we talked about a major theme across all of the three categories, and how to take advantage of what you see that could be there. That’s not there now. And that major theme is simply knowledge. I call it opportunity vision, but it’s not just about being able to see things, but you have to know what is possible.
First, you have to have the knowledge To know what is possible in order to know what could be their knowledge is, you know, where can you create a new value that does not currently exist in this picture.
You have to know what is possible. When you know what could be there with opportunity vision, then you can squeeze the most value out of each deal. And that’s really kind of what we’re talking about today. In our second episode on this topic, today, we’re going to talk about what you can do with the knowledge with the opportunity vision. How do you put this to work to create huge wins in your real estate investing business.
I wanted to remind you that I created a special tool just for this topic for you to download. It’s called the opportunity vision analyzer. So it’s a simple worksheet that will guide you through evaluating the different potential forms of opportunity that a deal might offer you and it gives you a way to score Each of those elements so you can ultimately determine which forms of opportunity are the best forms for you. And then you can craft your deal to focus on those best forms of opportunity. So, the link to this downloadable PDF worksheet, the opportunity vision analyzer is on the show notes page, which again, is it www.thoughtfulre.com/e24.
So let’s say you’ve got an opportunity that you’re looking at. And as you’ve evaluated it, you feel like you’ve captured a good assessment of every possible angle. You’ve looked to see what is there now.
And you know, what could be there? in all three ways, you’ve looked at it from the physical value perspective, you’ve looked at it from the income perspective, and you’ve looked at it from the financial structure perspective, and you feel like you’ve got a good assessment. So the question of course, is, well, now what you know in my own business, and I have developed a simple rule of thumb for deciding if I’m going to do a deal. And for quickly sorting through all the information and analysis I’ve done on a deal. And the simple rule of thumb is this. There always has to be something that’s absolutely awesome, about a deal.
Now, there might be multiple awesome things. And that’s, of course, even more awesome. But there has to be at least one thing that I look at it and I go, that is extraordinary. That is remarkable. That is way above average. And that one thing is awesome. And if I’ve got one thing that I know, I can make a deal work, and if there are indeed multiple things, I actually have to sift through those. And I have to decide what I think is the number one most awesome thing about the deal. So why is that so important? Right? If there’s multiple awesome things, then isn’t that a good enough scenario in the reason is that even if there are multiple fantastic things about a deal, as we put our deal together, we need to know our priorities for what we want to get out of the deal, which awesome things in which order are most important to us in this moment of what we’re trying to accomplish. And once we know that prioritization, we are then going to optimize our deal for the highest priority.
So optimization, I want to talk about this. I want to give you an example, an analogy. And the analogy is everybody’s favorite topic algebra. Okay. Don’t check out on me here. Okay. I know you might be having Middle School flashbacks right now, but we’re not going to get too into the weeds. I just want to remind you of the concept of algebra. Remember all those x&y formulas that you had in your algebra class? Well, as you might recall, the concept with algebra is simply to isolate the variable that you’re trying to solve for when the teacher says Solve for x in an equation, it’s about getting X by itself on one side of the equal sign, and then getting a number on the other side of the equal sign. It’s about isolating x and all the little maneuvers and calculations and things you would do, we’re all just little moves to slowly and progressively get x by itself on one side of the equal sign. In this analogy, your number one priority in the deal. This is the biggest, most awesome element of opportunity you see in the deal is like the x, it is the one we are going to be optimizing our deal for. In other words, it is the variable we are trying to solve for. This number one most awesome thing is x, that we’re trying to get X on one side of the equal sign.
Because remember, if you think back to algebra, you can’t solve for multiple variables, you have to pick one, really to solve for and even though there may be multiple awesome things about your deal, it’s important to pick one to really focus on wanted to make sure that you capture and if we can capture
others in the process also, that’s great. But we’re not going to sacrifice their main thing in order to get the other ones. In other words, if you could only get one awesome benefit from doing this deal, which one would you choose? Of all the ones that are there? If you had to choose one only, which element of this deal? would you choose?
Any further awesome perks that you get after that. That’s gravy. That is awesome. Bonus. Bonus awesomeness. As Stephen Covey has famously said, The main thing is to keep the main thing, the main thing. I love that quote. It’s so perfect, and it’s so simple but profound as well. We’ve just identified our main thing by saying this is the number one most awesome thing out of this deal that I’m now going to optimize for.
That’s our main thing that we’re going to keep the main thing so I’m gonna give Two examples, we’re going to start with one that is extremely relatable, and simple and very, very standard. Okay, let’s say that you have found yourself a deal that is a single family home.
And when you look at this deal, what you like about it is that it’s cosmetically ugly. And you know that other people, when they see it, they have a hard time seeing past that cosmetic ugliness. But you know, because you’ve got some experience and some imagination that this could be a much, much nicer house with really just a little bit of quite simple work.
So maybe some paint, carpet, maybe some new appliances, some staging, nothing really structural, maybe you’re taking down some dark window coverings and things like that, that open things up, but nothing really structural or complicated. needs to happen. It just needs a cosmetic overhaul for people to be able to see just how nice that it could be. And you know that if you could buy this house with in about six weeks, you can have it back on the market at a much, much higher price. And you’re thinking to yourself, okay, this is a great candidate for a flip. The seller is asking for a price that you actually think is fairly reasonable, you think you could make that work, but they do need to be paid in full at the time of closing. So there’s no opportunity as you’ve identified it for any type of seller financing. The zoning is single family and the house is indeed single family, the houses average size for the neighborhood, you could build an accessory dwelling unit perhaps if you wanted to. But there’s no obvious way to make the physical property something completely different than it is now because it already fits pretty well in the neighborhood is just kind of a rundown version of what surrounds it. You know, you could buy this house and you can rent it for a reasonable amount of money as well if you wanted to, but you’d also have to go and arrange some long term financing from another source. Because the seller is not able to provide it to you arrange long term financing in a way that would align with your rental plan. So you see that as a possibility, but maybe not your number one choice.
You know that the seller is flexible, and is reasonable in many ways, and they’re flexible and reasonable on things like the closing date. They’re reasonable and flexible on, you know, giving you the chance to do your inspections and conduct your own due diligence. And they don’t think any of the contingencies that you might want, you know, such as a due diligence contingency are unreasonable. So they’re pretty easy to work with in those ways. So you’ve got a good assessment of all the angles of possibility on this simple, single family home deal.
And you think that the greatest possibility lies in your ability to quickly resell this property for a significantly higher price and make a nice profit, right. So that’s sort of the epitome of what a simple flip is. So the thing you’re now working to optimize the deal for in your negotiation and your deal structuring is the spread between your buy price and your sell price. And at this point, you’re negotiating the deal with the seller. And so you’re focused on your buy price. So the variable in your algebraic equation of this deal that you’re trying to solve for is the purchase price. So that means that you decide that the other elements of the deal, they don’t actually matter to you nearly as much as getting the purchase price negotiated correctly. You’re willing to give willing to bend on other elements of the deal in order to make sure that you optimize for the most important thing that you need to accomplish, which is getting a great purchase price. That is the definition of keeping the main thing, the main thing in this case. In other words, as you’re negotiating with the seller, you are very flat Well, on the closing date, you’ll close when works best for them. Because that’s something that you’re willing to give and be flexible on. In order to make sure you get the thing you need and you want, you’ll finance it however you need to, in order to facilitate this process. If the seller says I don’t want to wait 60 days while you go get a bank loan, you find a way to say Okay, no problem because you’re focused on getting the main thing out of this negotiation that you want to get out of it, which is negotiating the right purchase price. All your focus goes on negotiating that purchase price at the expense of all the other things in the deal. Because you’ve decided that’s what’s most important in order to extract the biggest angle of value that you have identified. Some might say this is the hill you’re going to die on. You’re not going to go to battle and, and die on the hill of closing date or contingencies or things like that. You’re going to die on the hill. purchase price. So you’ve probably done this deal before. This is a very simple, very relatable example, which is why I wanted to start with it.
Maybe you just didn’t realize that as you were doing this, you were quote, solving for price that the variable you’re optimizing for in this algebraic equation was price. Or maybe you thought that solving for price is just what you do all the time that there is no other thing to solve for that there is no other algebraic equation.
And that that’s just what you do in every deal. And truthfully, many people think that’s the case. In fact, I would say that is a hallmark of kind of the low brow real estate investor approach, which is that they don’t think there’s anything to really go to battle for besides the purchase price. Now, don’t get me wrong, you’re always going to get the best purchase price you can, but sometimes you will not focus on that as much in favor. Focusing on other things that are more important.
And on that note, let’s talk about example number two, which is a little bit more advanced of an example. Now I’m modeling this example a little bit after a deal that I did over the last year. It’s not exactly that scenario. But the scenario itself is quite similar. And some of the thoughts that went through my head as I was negotiating that deal, were similar to this little case study example. So let’s say that you found a triplex three units that’s not being managed very well and clearly has not been managed very well or maintained very well for a long time. This building is really perfectly appropriate for the neighborhood. It’s similar to the buildings around it, it fits the zoning well. One of the units is totally vacant. Two of the others are renting for $950 a month but you know, the market and you know that, if improved and managed properly, the market would be happy to pay 1600 dollars a month for these units. Okay 950 now could be 1600. You know, they’re going to have to make some improvements to the property, especially to the interiors of the units to get it there. And that’s going to mean doing a full cosmetic overhaul of this property, as well as a couple important mechanical upgrades, such as things like the roof because the roof is leaking in a couple spots. Now, you can’t just kick out the existing to tenants, because the local rules in your city just don’t allow you to do that very quickly or easily. You would have to maybe even provide them with relocation assistance, which is a payment to help them move and to cover their moving costs and you’re gonna have to give them a lot of time to do so. So what you know is between the physical renovations and between the tenant move out and turnover timeline, it’s going to take a while to gradually get this property up to its full potential. You think it could take upwards of a year before it is fully up and running in the best possible version of itself and generating full market rate income, but you’d love to buy this property, and you’d love to keep it as rental because it’s in a great location. The seller is asking for a sales price of $350,000, which isn’t stratospherically unreasonable, but you feel that in its given condition. And its state of affairs with its income stream, it’s worth closer to $300,000 right now. So there’s a little difference between what you think is the right price and the price that they’re asking. You’re concerned that if this property has an appraisal, it’s not going to appraise for $350,000. And that means then it actually might not even be financeable at all given the condition. If the appraiser shows up and sees that there are leaks in the roof, they might say it’s not even financial in this case. And that that would have to be remedied before financing could be placed on the property. You think with about $100,000 in work total, this property could be worth approximately $675,000. So there’s a huge opportunity to build a lot of equity and generate some great cash flow in the process. You’re looking at this thinking this would be an excellent long term hold for your portfolio, and would build wealth for you over many, many years to come.
Because without hundred thousand dollars in work, not only have you physically improve the property, you’ve now enabled yourself to charge market rents. And now the whole property is worth so much more than what you’ve got into it. So you’ve got a good assessment of all the angles of possibility on this deal. You think the greatest possibility really lies in your ability to build a lot of equity very quickly, and to create strong cash flow by improving the property and re renting it at market rates. And holding it for a long time in your portfolio. So the question is, what are we going to optimize for? And I would say to answer this question, let’s ask ourselves a slightly different question. What is the biggest challenge or roadblock to executing the vision, the plan that I just described? And the answer, or at least one of the answers, but certainly a major answer is covering the cost of owning this building for the many months it’s going to take to get it up and running, you know that this property is not going to pay for itself and be in the black cash flow wise, for several months. So how do you survive those several months? You know, you don’t want to be severely upside down each month for maybe upwards of a whole year. So the question is, now we know that’s kind of the impediment to our plan. What would help solve that problem? What would help remove that impediment? The answer to that is if your monthly costs were reduced or eliminated for several months, while you got a head start with your whole plan to improve the management, replace the tenancy and improve the physical aspects of the property. If your monthly costs could be reduced or eliminated for several months, while you invested in the property, that would remove the problem. So that is what we are going to optimize our deal for keeping our monthly costs as low as possible for the first say, six to 12 months. And when we look at our monthly costs that we want to keep as low or even eliminate, what are our biggest monthly costs? Well, it’s usually debt payments, right? It’s usually loan payments, sure, their taxes, sure their insurance, things like that, but really, the biggest chunk of change happens to normally be our loan payments. And I wanted to point out that it’s not that we You’re trying to avoid the cost of having debt payments on the property, it’s really more about the timing of those debt payments. The problem is that you’re making loan debt payments at a time when the property is not producing rents and income to cover that. So it’s not that we’re trying to avoid the cost of the debt. It’s really about the timing of those debt payments. That is troublesome to our plan. We’d rather pay those same costs later, when the property is performing better. So this, the variable that we’re going to solve for in this algebraic equation of this deal, is our monthly payment over the next 12 months over the first 12 months of ownership. Having our monthly payment be workable, is the thing that we are trying to solve our equation for. That means, of course, then that you decide that the other elements of the deal don’t actually matter as much to you, as structuring a deal where your monthly costs are at an absolute minimum. For that first year. In other words, you’re less concerned about negotiating every single little dollar on the purchase price. You’re less concerned with finding every little tiny thing that’s wrong with the property and making sure that the repair addendum type of inspection findings, you know, every little broken doorknob is accounted for somewhere the other you’re not worried about those things, because you decided that the number one thing you are going to optimize your deal for, is negotiating lower loan payments for the first 12 months. That’s where all your focus goes. That is the main thing that you’re keeping the main thing. It all goes all your focus on negotiating the terms that will enable you to keep your first 12 months of costs low at the expense of all the other stuff. Because you decided that in order to extract the biggest angle of value from this deal, that is what is most important. Okay, let me give you A quick bonus thought on this example. I want to get more concrete with this example for just a second. What might that look like a situation where your monthly costs are minimized for the first year? Well, here’s a couple different ideas. The first idea is simply that you agree in your negotiations to pay the seller, the higher price that they have been asking for. Even if you don’t think it’s really worth the full 350, you think it should be 300 if they’ll do the 350 with you, and they can provide seller financing to you for 18 to 24 months. That could be a great win. That could be a great way to structure this. Maybe you say interest on that loan does not begin accruing for 12 months, and then 30 days after that, the first payment is due. So the sellers getting their higher purchase price that they really want in exchange for providing you with flexibility that eliminates in this case your debt payments for those first, say, year to 12 or 14 or 18 months. A plan B version of this same concept. If the seller would not agree to waiting 12 months before interest accrued would be simply to say interest begins accruing at closing, but no payments on that accrued interest are due for 12 months, that would be another way of accomplishing a similar type of thing. It wouldn’t be quite as good for you as having no interest accruing during that period. But at least again, you’re delaying the payment of your debt service to a time when the property is producing stronger income. Here’s another example. Instead of that structure, with deferred or deferred accrual of interest with seller financing could be that you structure this deal as a lease with the option to buy. So in this case, you would become the lessee to begin with instead of the owner, but you would have an option to buy the property. And let’s say your lease payments then for those first 12 months are next to nothing. And so you don’t actually begin owning the property for those first 12 months, but you have control of the property and allows you to get in there, take control of the property and for the next 12 months, do the work, manage the tenant turnover, improve the property. And then once you have made major strides on that, you can then exercise your option to buy the property.
Because at that time, now that you’re going to exercise your option, which is now the time you’re going to transition from being just the lessee to the actual owner of the property. At that point, you’ve got an excellent property that’s going to qualify for a much better long term rental Type friendly financing. So that would be another way to structure a deal that would keep your costs very, very low for the first 12 months. So you could focus on improving the property.
Let me give you a bonus to the bonus.
You might be asking yourself why the seller would be willing to do one of those two things. And I want to make sure that this part is very clear, so that you realize how very possible these things are. Why would the seller be willing to do this? Well, there’s always a million possible answers to that question. But in this case, there are a couple important points I want you to take away from this. If outside financing like a bank, for instance is involved, that is going to mean an appraisal. Having an appraiser come visit this property in its current condition with the leaky roof of vacant unit and to less than desirable tenants is not in the best interest of the seller. And the appraiser might even find That the property is not financeable in its current condition, it most likely will simply not appraise at the price that the seller is wanting to sell it for. So it actually is in the seller’s better interest to not have a plan that requires an appraisal and an appraiser. So if the seller wants to get their price, then they’re going to be incentivized to be as flexible with you as they possibly can be. And if they can be flexible with you on financing, for that first 12 months of your taking this property over, let’s say at least first 12 months, say 12 to 24 months, maybe they gave you a little cushion, if they want their price.
They will be incentivized to be flexible with you on financing for that first 12 to 24 month period in order to allow you to improve the property before seeking long term financing because from their perspective, right, from their perspective, they to have a main thing They’re keeping the main thing, the main thing. And if if in this case, their main thing is wanting to get their purchase price, right, they’ve got this $350,000 mark in their mind. And they’re saying that’s what we want. They’re keeping the main thing, the main thing, which means they’re less concerned about some of the other elements. And they were possibly much happier to simply be flexible with you to provide the financing you need that allows you to pay them the price that they want.
So in summary, over the last couple episodes, we’ve talked about, and looked at the various aspects of opportunity vision, this is seeing not only what is there, but what could be there, and then taking action to optimize our deal to ensure that we capture the maximum value that this opportunity presents to us. One more reminder of the special tool that I created for you just for this topic, called the opportunity vision analyzer. It’s a simple worksheet that will guide you through the process of evaluating the different Potential forms of opportunity that a given deal can offer. It gives you a way to score each element so that you can ultimately determine which forms of opportunity are the most awesome ones you want to focus on and the best fit for you and then you can craft your deal to focus on those things.
You can get the show notes for today at www.thoughtfulre.com/e24. And that is exactly where you’ll find the link to download the opportunity vision analyzer. As always, thank you so much for listening to Sleaze-Free Real Estate Investing. On the next episode, we’re going to dive into a discussion on direct mail marketing. So again, please do yourself do us a huge favor by hitting the subscribe button and your podcast app. We really appreciate that and then that way you’ll know exactly when the next episode is released to hit up those show notes at www.thoughtfulre.com/e24 and until next time, this is Jeff from The Thoughtful Real Estate Entrepreneur. And signing off