There's an old saying in real estate, “Money is made on the purchase, not on the sale.” In this post, I'll explain what money is made on the purchase means and why it's so true.
Getting a great deal on a real estate purchase is very important. And there are so many things we can do to make a great deal happen.
Why Money Is Made On The Purchase In Real Estate
A nearby house on the same side of my street sold for $1.56M. The house is the same style as mine with a similar floor plan, but has a 20% smaller lot and slightly inferior views due to a couple of trees blocking the ocean.
The neighboring house was in mediocre shape just like my house was when I purchased it for $1.23M in early 2014. Basic math shows a ~27% appreciation in 2.3 years, or a 134% cash on cash return based on a 20% down payment.
In retrospect, parlaying an expired 4% yielding CD into SF real estate was a good move so far. Let's see how much the market corrects this time around.
Skillfully Negotiating The Real Estate Purchase
I invited the selling agents, Nancy and Bob over after the sale to get the skinny on the market and provide an assessment of my home. After about four days of deliberation, they sent me a detailed valuation analysis report and said “they were 85% certain they'd be able to get at least $1.85M – $1.9M for my house.”
The total return would therefore be 31%-35% or a 155%-175% cash on cash return on the down payment if you include my ~$170,000 in remodeling costs. Gross profits = $440,000 – $490,000.
All these figures don't mean anything until my property actually sells. These figures are just nice to know in case I change my mind about holding San Francisco property forever. No other international city is so cheap with so many growing companies paying so well. If you have the proper skill-set, your income potential is incredible.
Check out the average salaries of software engineers for some of the largest tech/internet firms. Multiply these salaries by two and you've got a typical homebuyer on the West Coast.
Purchase Negotiations Is Everything
Here's where things got interesting. Nancy and Bob mentioned they were the realtors who represented the only other competing buyer on my house back in 2014!
John, the listing agent from 2014 was from out of town and listed my property as a favor to the sellers because he grew up in the house next door before he went off to college. He represented two sisters who moved to Washington. At age 73, John retired years ago from his day job in manufacturing.
The original asking price for my house was $1.24M and I offered $1.18M because it was on the market for four weeks already – on the longer end for SF standards. John had an offer date at the end of the third week but didn't receive anything good enough for them to accept.
Anchor Your Real Estate Offer Low To Get A Better Deal
John wasn't happy with my $1.18M offer because his buyers were expecting “way over asking” in the $1.4 – $1.5M range But John accepted my verbal offer after I told him I'd work directly with him. A buyer utilizing the listing agent to represent them can be an advantage. This is called dual agency.
This way, he wouldn't have to pay the buyer's agent their half of the total commission = $30,000. Having the selling agent represent you is a great strategy if you know what you're doing and trust the person.
I remember sitting down with John at the 1940s kitchen table listening to all his stories about the neighborhood growing up. He told me about a famous author that lived close by in the 1960s. He mentioned how the builder, Henry Doelger, lived in the mansion across the way. I even asked him for some life advice if he was 37 again. He said, “I would have saved more.“
After a couple hours of getting to know each other, we shook hands old school style about my $1.18M offer and my promise of working with him to make the transaction as smooth as possible. We hadn't signed any papers yet, but I felt he was someone I could trust.
The Squeeze To Lower The Purchase Price
A day later, John came back to me all conflicted and said he had another higher offer that he had to present to the sellers. Buyers seem to come out of the woodwork once they know an initial offer has been placed. Although disappointed, it was his fiduciary duty to his sellers to present all offers.
I already knew I was getting a deal at $60,000 under asking based on the comps at the time. He was a retired agent who poorly marketed the property. In addition, he had zero pictures on the MLS and a broken “for sale” sign in the window. He didn't know how to leverage the internet, which was why the property was so under-marketed.
I just so happened to be driving around the neighborhood looking for ocean view homes when I saw the broken “for sale” sign.
After a long walk in the park, I called John and begrudgingly raised my offer price by $50,000 to $1.23M. I told him this was my best and final offer. I reminded him of our handshake agreement as well. Once he heard the news, he told me he would ignore the other buyer no matter what they countered.
Until now, I always wondered whether John was a grandmaster negotiator who bullshitted me into raising my offer price with a fake “I've got another higher offer” move. It's a common tactic to create emotional anxiety in potential buyers to raise their offers. Now I know he was being honest.
“We Would Have Offered Way More”
I told Nancy and Bob, the prospective realtors visiting my house this story and they told me their clients would have offered “way more” back in 2014. When I asked how much more, they responded, “up to $1.35M!”
$1.35M is in the ballpark because that would mean the property is up a realistic 15% in 2.3 years based on the $1.55M comp that just sold in 3Q2016. 15% is still a healthy 75% return on a 20% downpayment.
I asked Nancy and Bob why they didn't just offer more to win? They said when they contacted John to make the counter he told them that the deal was already ratified. He ignored their request! This time, John fought for me.
If you don't have the ability to make such a close connection like I did with the listing agent, write a real estate love letter. The real estate love letter will humanize your offer and convince the seller to go with you instead of someone else.
Building A Trusting Relationship Is Key To Getting A Better Real Estate Deal
Spending a couple of hours getting to know John basically saved me +$120,000 because I also would have come up to $1.35M back then if necessary. I had lost out on a property the month before where I offered $1.51M and the winner offered $1.8M! That house was listed for $1.2M. Nutso.
John told me he retired with enough money to live out his days. Therefore, his priority wasn't trying to get top dollar. Instead, he was more interested in getting the transaction done in as easy a manner as possible.
This is EXACTLY how I feel as an early retiree. Once you have enough money, the desire for more money begins to fade. You just want a big fat easy button you can press to make things happen.
Key point to remember. In real estate, getting the purchase right is paramount. You can always refinance your mortgage, but you can NEVER change your purchase price! This is one of the key reasons why money is made on the purchase.
A great purchase price helps create a perpetually lower tax basis, at least here in California due to Proposition 13. A great purchase price also improves your internal rate of return.
Purchase Negotiation Recap
Here's a recap of why money is made on the purchase.
1) Understand what the sellers and the realtor want beyond just a high price.
Maybe the sellers want a three month rent back period so they can do a 1031 exchange. Be flexible moving in.
Maybe the sellers want to make sure the new owners keep their 70-year-old oak tree. Tell them you'll not only keep the tree, but prune it regularly and plant another oak tree to keep it company. They will love you for saying so due to the emotion attached to real estate. Listening is a crucial skill.
2) Be a person of your word.
There once was a time when your word was your bond. Now people flake all the time because they are dishonorable and selfish. A person of their word shows up on time, responds to all phone calls and e-mails immediately, and commits to specific transaction milestones as expected, e.g. 3% deposit earnest money.
3) Build a relationship with the seller and the agent.
Write letters. Send pictures. Spend as much time talking in person or over the phone. Understand that it's much harder to screw a person over once they've developed a connection. The same concept goes for people trying to negotiate a severance. Most of you would never screw over your parents, siblings or loving spouse just for more money. People take care of people they like.
4) Get smart enough to thoroughly understand the real estate transaction process.
Under the documents so you can use the strategy of convincing the selling agent to represent you. You'll not only get the inside scoop on everything that comes up, you'll also be able to split the 2% – 3% commissions he saves by representing both sides. The internet should give you 80% of the information needed to transact. The other 20% will be gained by you poking holes in the drywall.
In November 2023, it was found by a Missouri jury the National Association of Realtors, Keller Williams, and HomeServices of America colluded to keep real estate commissions high. Therefore, if you plan to buy or sell in the future, you should aggressively negotiate down the commission price.
5) Methodically grow your network.
Your local realtor community is relatively small. The more people you know, the higher your chance of getting a heads up on an off-market opportunity or close a deal on more favorable terms.
Let's say the average person owns a home for 7 years before selling or moving. If you just get to know one realtor a month through leisurely open house hunting, you'd grow your network by 84 realtors.
The house we purchased in 2014 has turned out to be a home run. The walk-out deck off the master bedroom is done. I've frequently used the lower portion of the house during the pandemic as a sanctuary to write and enjoy the hot tub.
The joy of real estate blows away the joy of investing in the stock market. It's no fun being a passive investor collecting dividends while the real money gets made by senior management and majority shareholders.
Being able to take advantage of a 2.5% mortgage rate while also being able to deduct the interest off my income almost feels illegal. Knowing the property has appreciated by 60% – 70% since 2014 is just icing on the cake because I don't plan to sell.
6) Consider writing a price concession letter
Years later, I bought another house in 2019 and another one in 2020 after the lockdowns began. During both times, I was nervous about the purchases. As a result, I wrote a price concession letter after getting into contract.
The first price concession letter saved me $10,000. And the second price concession letter saved me $5,000 off closing costs and bought me one month more of time.
Although writing a price concession letter might seem a little shifty, if you write one in a respectful manner, it could help you save money. You will never know until you try!
Money Is Made On The Purchase
Buying real estate can be daunting, but it doesn't have to be. Do your best to think logically and not let your emotions get in the way.
Remember that money is made on the purchase because you're spending less than necessary through skillful negotiation. Money is not made on the sale because a wise person holds forever.
Real Estate Recommendation
Now that you know money is made on the purchase, not on the sale, it's time to buy. Real estate is my favorite asset class to build wealth. It generates income, provides shelter, and is much less volatile than stocks.
Take a look at Fundrise, one of the largest and most innovative private real estate managers today. Fundrise is the pioneer of the diversified eREIT fund. It runs over $3.5 billion in assets and has over 400,000 investors. Fundrise primarily invests in Sunbelt residential real estate where valuations are lower and yields are higher.
Another great real estate investing platform is CrowdStreet. CrowdStreet mainly focuses on individual real estate opportunities in 18-hour cities. 18-hour cities tend to have faster growth rates, lower valuations, and higher yields. If you are a real estate enthusiast and accredited investor, you can build your own select real estate fund.
I've personally invested $954,000 in real estate crowdfunding since 2016 to diversify and earn more passive income.
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Money Is Made On The Purchase is a Financial Samurai original post. I've been helping people achieve financial independence since 2009.