As real estate investors, we’re always looking for a great deal. Residential investors know that off-market opportunities tend to have more profit potential than properties listed with an agent on the MLS. That’s why wholesalers, flippers, and buy-and-hold investors use direct-to-owner marketing campaigns to build their deal pipeline. These strategies include driving for dollars, cold-calling, direct mail, SMS, and bandit signs.
Commercial real estate investors love off-market deals as well, but the idea of cold-calling a list of apartment owners and convincing someone to sell to you for 50%–70% of the current market value is certainly more challenging than with residential. It requires a fair level of sophistication to own, finance, and manage commercial real estate. Unlike a homeowner, who may buy a house and never consider rental comps or appreciation potential, CRE investors buy properties based almost exclusively on their financial viability.
While CRE investors are more discerning, there are still opportunities to find off-market deals. First, let’s recognize that the majority of property owners would tell you that selling through a broker or agent will generate the highest sales price for the property, yet there are still reasons an owner may decide to list off-market.
Many brokerages want to create a reputation for delivering quality, desirable assets for their clients. To develop this reputation, they have created a standard of the types of properties they will and will not list. If a property does not meet this standard, either because of current condition, location, or other factors, they may decline to take on a listing.
A broker may provide feedback to the owner to make certain improvements before they list the property, but if the owner really wanted to make those improvements, they would have already been done. The owner is now faced with making an additional investment on an asset they want to sell or find someone willing to buy the property in its current condition. In this situation, many would welcome an off-market buyer if they felt the offer was fair.
Some owners simply don’t value agents and brokers enough to pay them a 3%–6% commission. That fee comes out of their proceeds, so it’s understandable that they would question how much they could get if they cut the broker out of the equation. Consider if you were to sell a property for $1 million. At a 5% commission, you would pay a broker a $50,000 commission. Even if you assume that you made a 50% profit on the transaction, it still equates to giving 10% of that profit to a broker.
This isn’t to argue that a broker isn’t valuable or deserves a smaller commission. However, for investors focused on returns, you might understand why some may question just how much value that broker is bringing to the table. This is especially true if the deal is being marketed broadly on the MLS or other public platforms.
Another reason owners may not list with an agent is because they want privacy and discretion. I recall speaking with an owner of an apartment community in a smaller town who did not want residents or other people in the community to know he was selling the asset. He was highly involved in the community and felt he would face backlash, so he urged for discretion throughout each element of the transaction.
Other owners may have family members or staff members who will express concern or frustration, so they want to minimize that impact by keeping the transaction private. Selling to an off-market buyer is easier in this case, compared to listing the asset publicly and holding tours with multiple buyer groups.
The last reason an owner may look to sell off-market is the need for a quick closing. This is usually triggered by some other event like an unexpected financial burden, divorce, or death. For owners looking for a quick close, the penalty for missing a deadline may be too severe to go through a traditional listing process. Instead, they are willing to accept less money for the certainty of closing, allowing them to handle the underlying issue that triggered the transaction.
In these instances, an off-market deal may be ideal, but sellers still want to work with someone who helps them address the underlying issue. For instance, if someone has inherited a property, they may not want to deal with the grief that comes with removing personal items from the home. A buyer who is willing to move these items is helping to address the underlying issue, not just close quickly.
For commercial deals, it could be a partnership dissolving, a loan reaching maturity, or a 1031 exchange. Buyers need to focus on the underlying issues, not just a quick close. These solution-oriented buyers are more likely to close on the off-market deal, as opposed to those focused only on price.
Sophisticated owners are less likely to tell you how desperately they need to sell their property and want to remain in a position of leverage for negotiations. This is why it’s important to establish the owner’s level of motivation before making an offer. If someone has hired a broker to list the property, it’s clear that there is at least some base level of motivation. However, this is harder to determine when you go directly to the owner.
To determine motivation, you will need to pay attention to the physical condition of the property, the financial health of the property, and the owner’s alternatives.
If you have been able to view the property, look for deferred maintenance, recent upgrades, and major work that may be needed soon. If the property has been owned for a long time, many of the big-ticket items may be nearing their end of use and this expense could wipe out a significant chunk of profits or savings for an owner. Selling may become more viable for these owners. On the other hand, owners who have recently made major investments may be ready to cash out of the property while the physical appearance is at its peak.
When reviewing the financials, look to understand the financial health of the property. Is there strong cash flow, or is the property upside-down? The stronger the cash flow, the less motivated that owner is likely to sell. However, owners with lower cash flow or those who are not optimizing the property are more likely to sell. For instance, just this week, I looked at a property where the annual cash flow was -$300,000. As you can imagine, this group was highly motivated to sell.
The last factor is critical. What are the owner’s alternative options? If they can simply continue to own the asset without any changes in the foreseeable future, they are not going to be highly motivated. However, if the alternative is to list it with a broker or try to sell another asset, you may have found a highly motivated owner.
When looking to determine this level of motivation, a great question to ask is: “What will you do if you’re not able to get your asking price?” This will give you a real glimpse into their motivation and feedback to adjust your offer accordingly.
Finding off-market deals is a profitable way to scale your portfolio and rely less on brokers. The key is identifying motivated sellers and creating offers that address their concerns and needs.
While commercial real estate investors tend to be more sophisticated than homeowners, there are still situations where they prefer to pass on listing with a broker. If you can identify key indicators around their motivation, you will be able to create a pipeline of off-market opportunities.
About the Author:
John Casmon has helped families invest passively in over $100 million worth of apartments. He is also the host of the #1 rated multifamily podcast, Multifamily Insights. Prior to multifamily, John was a marketing executive overseeing campaigns for Buick, Nike, Coors Light, and Mtn Dew: casmoncapital.com
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.