In a strong housing market, you need to utilize every strategy possible to try and get a good deal. This post will teach you how to purchase property below fair market value.
Buying a property below fair market value is possible with just a few words. However, you must really make the effort if you want to get a good deal.
In real estate, there’s a saying that goes, “money is made on the purchase, not on the sale.” With a well-timed purchase, you get to pay lower property taxes over the life of ownership and generate a much higher compounded return due to a lower base.
The market is a wonderful place because it allows two people with opposing views to swap assets at an agreed upon clearing price. But I had to keep a poker face during my SF real estate purchases in 2003 and 2005 because deep down I was thinking, I can’t believe they are selling for so cheap!
Even with my single family home purchase in 2014, I couldn’t believe they were selling a panoramic ocean view home on a double lot for 40% cheaper on a price/sqft basis than property on the east side of SF. No other major city in the world has ocean view properties that trade at a discount.
But now that the property market is hitting record highs across the country, as the pandemic has created huge demand for nicer and larger homes. Further, mortgage rates are at close to record-lows and will likely stay at record-lows for a while.
As a result, it’s a good idea to negotiate more aggressively, just in case you buy at the top of the market. You also want to run the numbers over and over again and make sure you follow my 30/30/3 home buying rule.
Here are three strategies that may get you up to 5% below fair market value for a property.
How To Purchase Property Below Fair Market Value
All information can be relayed via a formal letter to the seller or via an e-mail from real estate agent to real estate agent. The transaction period usually lasts between two weeks to two months, so you’ll have time to negotiate fine details.
If ever there was a time to improve your written communication skills, now is the time! To purchase property below fair market value, you must learn how to write a real estate love letter.
Let’s go through three specific tips.
1) Focus on making a connection.
It’s important to find some common interest between you and the seller. You can always find out something about the seller’s background via an online search. People tend to like others with similar interests. Just look at how top management at companies all look the same.
Tell the seller how much their home would mean to you. Talk about the children you plan to play with in the backyard. Talk about your shared love of the Golden State Warriors. Salute their charitable efforts. In your letter, it’s important to share with them who you are and why you are good people.
Selling a home is extremely emotional, especially if you’ve lived in it for many years. A seller would much rather sell to a family who works at a non-profit looking to eradicate poverty than to a 25-year-old trust fund kid whose parents are paying the entire downpayment, all else being equal. Tell your story in a positive light by sharing the struggles you had to overcome.
The purchaser of my home wrote a nice letter that told me how much he loved my house’s brick facade. It reminded him of the colonial homes in Virginia where he grew up and went to college. Given I, too, went to high school and college in Virginia, I was more willing to entertain his offer, especially since he and his girlfriend had a two year old son.
2) Allude to end of the world scenarios.
It’s much more stressful being a seller than a buyer. Buyers can simply shop around with no commitments. However, the seller is putting himself out there by listing his property online, signing a contract with a real estate agent, and allowing strangers to go through his home. Understanding this dichotomy will enable you to buy property below fair market value.
The seller also knows that if they don’t sell within a certain period of time, the property goes “stale fish.” It’s embarrassing when you put yourself out there and get rejected (no sale).
As a result of so much worry and stress, using “the end of the world” strategy can really motivate your seller to offload. You can start off with big picture scenarios such as discussing what would happen to the property market if the stock market has a 50%+ correction like it did during the 2008 – 2009 financial crisis.
Frankly, talking about doom isn’t too far-fetched given the coronavirus pandemic and the 32% S&P 500 correction in the month of March 2020.
Then you can go on to discuss what would happen if there was a terrorist attack. Finally, you can talk about natural disasters like earthquakes, flooding, and fire wiping away their property for good.
Bad Things Happen All The Time
Your goal is to make the seller believe their house is a riskier asset than it really is. When I was in the process of selling my rental property, I kept thinking how lucky I was to have escaped a big earthquake during my 13 years of ownership.
The house was in The Marina district, which has loose soil that’s susceptible to liquefaction. Every San Franciscan is waiting for the big one to hit in the back of their minds.
If the buyer smartly pressed on the risk of damage in an earthquake by asking me about the soil underneath the house and whether I had experienced any earthquake damage during my time of ownership, I probably would not have negotiated as hard.
I would have sensed his fear of risk, which would in turn made me more fearful of losing him as a buyer. The key is to ask about the potential risk of each scenario, and not tell. Asking gets the seller thinking about worst case scenarios.
3) Focus on the benefits of a simple life.
Life is much simpler renting and owning fewer things. A simple life is the reason why I’m not in a rush to buy another physical property. Bad tenants, leaky roofs, endless maintenance, and ever increasing property tax are terrible things. A simpler life is why I’m focused on real estate crowdfunding. If I can earn 10% – 15% a year without any hassle, I’m all for it.
The older the property seller, the more appealing a simple life free from property maintenance will be. After a decade of homeownership, a property owner will have experienced more than her fair share of troubles. But you can still argue about the joys of simpler living to younger property sellers too because they can definitely remember what it was like as a renter.
Highlight Your Value-Add
The way to convince the seller about the benefits of a simple life is to highlight all the remodeling and upgrades you plan to do to the property. Not only do you make the seller feel good knowing you plan to take care of the house, by discussing all the work you plan to do, you also remind the seller how much work she has to do if she were to keep the property.
My old house’s kitchen and two bathrooms were last remodeled in 1995. I had a 20+ year old HVAC unit that needed replacing. My back windows leaked, no matter how much I caulked around them. I also had an intermittent leaky light well that dripped through my dining room ceiling.
If I kept the house, I would have needed to spend $100,000 – $300,000 on remodeling. The whole process would have been a huge pain due to unreliable contractors, the need for permits, and multi-stage inspections by the city. I wasn’t going to spend that much money and time for a rental, so I let it go.
Work On Your Persuasion Skills To Buy Below Fair Market Value
Everybody has their preferences. If you can figure out what they are and make a connection, you can probably get at least a couple percentage points off fair market value. After about 5%, financial fundamentals take over. This is true for any negotiation situation.
If my SF rental house buyer could have made a connection with me over tennis and got me paranoid about an 8+ Richter scale earthquake hitting SF in the next five years, I probably would have sold the house for $140,000 less (5%) than I did. Even 5% less was still 4% higher than my aspirational selling price.
But don’t feel bad for my buyer. My house will do very well for him given how strong the SF economy is. I’m the one who occasionally feels bad about selling until I remind myself how difficult it was to deal with tenants and maintain a 1926 built house as a landlord.
It also feels nice to no longer owe a mortgage and write $24,000 property tax checks every year. Spending time stressing over my rental when I could be spending time with my son would seriously piss me off.
For those who choose to rent, that’s OK too. Follow my Buy Utility, Rent Luxury strategy and continuously invest your extra cash flow to beat inflation.
I’ve personally decided to sell an expensive San Francisco real estate for a price that equaled 30X its annual rent, and reinvested a large portion of the proceeds in various passive income investments. Not having to deal with ownership headaches is amazing.
If you remain disciplined by consistently investing the difference, you’ll do fine. But if you don’t, you’ll wish 20 years from now you held onto your property or bought a property today.
Diversify Your Real Estate Investments
Buying a property below fair market value is awesome. You get to live it it, enjoy it, and hopefully build long-term wealth. However, to get rich off real estate, you must investment beyond your primary residence.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
Take a look at my two favorite real estate crowdfunding platforms.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
Both platforms are free to sign up and explore.
I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.