Chapter 16 TWO PRIME INSIDER TECHNIQUES Flashcards
1
Q
What are the two negotiation strategies introduced in this chapter?
A
Preferred income sweeteners and options.
2
Q
What is a common reaction of buyers regarding seller statements?
A
Buyers often do not take seller statements at face value.
3
Q
What can cause misrepresentation of income and expenses by sellers?
A
- Seller stretching the truth
- Honest mistakes
- Different accounting procedures and terminology.
4
Q
How can time affect real estate transactions?
A
Time can be an equalizer and is often tied to the value of the transaction.
5
Q
What is the role of preferred income sweeteners in negotiations?
A
They can help close transactions when there is a lack of agreement on the property’s value.
6
Q
Fill in the blank: Preferred income sweeteners are often found in _______.
A
[joint ventures or partnerships].
7
Q
What does a preferred income sweetener offer to a partner or lender?
A
A piece of the income as an incentive for their capital investment.
8
Q
True or False: Preferred income sweeteners diminish the return of the originator of the deal.
A
False.
9
Q
In Example 1, what return percentage was agreed upon for the investor’s $500,000?
A
12 percent.
10
Q
What is the significance of a preference on income in a partnership?
A
It ensures that the partner receives income before the originator.
11
Q
What is the outcome if net operating income (NOI) falls below projected levels in Example 1?
A
The cash flow would be zero and no income would be divided.
12
Q
What strategy can be used to entice a seller to hold a mortgage?
A
Offering a sweetener of extra return based on the property’s income performance.
13
Q
Fill in the blank: A sweetener can be anything you can offer another party to _______.
A
[close the deal].
14
Q
What is one primary rule of smart investing mentioned in the chapter?
A
Reduce your risk.
15
Q
How can a buyer reduce their risk in a transaction?
A
By negotiating preferred income positions.
16
Q
What are tradeoffs in the context of negotiations?
A
Adjustments made to meet the needs and goals of both the buyer and seller.
17
Q
True or False: A buyer should avoid discussing their price with the seller.
A
False.
18
Q
In Example 2, what was the proposed interest rate offered to the seller?
A
9 percent.
19
Q
What is the benefit of offering a sweetener based on the property’s performance?
A
It aligns the seller’s interests with the buyer’s investment performance.
20
Q
Fill in the blank: The seller’s increase in interest depends on their _______ in the property’s performance.
A
[confidence].
21
Q
What can be a potential negative effect of the ‘take out’ scenario?
A
It may create a mortgage situation from day one.
22
Q
What is the first step in negotiating a purchase with a seller?
A
Tell the seller you are interested in buying and ask for their price.
23
Q
What motivates a seller in a negotiation?
A
The seller may be willing to settle for less than their goal if it meets most of their motivations.
24
Q
What is an example of a preferred purchase to sweeten the deal for a seller?
A
Offering a substantial cash amount to the seller.
25
What is the asking price of the office building in the first example?
$6,000,000.
26
What is the NOI of the property in the first example?
$540,000.
27
How much can the buyer borrow at a constant annual debt service of 8.29 percent?
$4,800,000.
28
What is the cash flow if the buyer purchases the building for $5,500,000 and invests $700,000?
$142,080.
29
What is the cash flow yield on the invested capital of $700,000?
20 percent.
30
If the seller is firm on a price of $6,000,000, what counteroffer does the buyer make?
Offer $6,000,000 with a second mortgage of $900,000.
31
What is the total annual debt service after the buyer's counteroffer?
$411,750.
32
What is the cash flow after the buyer's counteroffer?
$128,250.
33
What percentage yield does the buyer achieve on their $600,000 cash investment?
21.375 percent.
34
What financial aspect does Charles need to manage in the second example?
He needs cash and is considering selling his office building.
35
What is the gross revenue reported by Charles?
$850,000.
36
What is the cash flow if the buyer pays $1,450,000 cash for the deal?
$150,000.
37
What percentage return does the buyer receive on their investment of $1,450,000?
10.3448 percent.
38
How much cash does the buyer offer to purchase 50 percent of the building?
$800,000.
39
What is the preferred return the buyer seeks from their cash investment?
12 percent.
40
What are some benefits the buyer seeks from the deal?
* Preferred income
* Depreciation
* Share in proceeds.
41
What happens if the cash flow is less than the preferred return?
The deficit can build up and add to the buyer's investment.
42
Why would a seller accept a deal where they keep a 50 percent stake?
They receive cash and still have a stake in the property.
43
What is a potential negotiation point to reduce risk for the buyer?
Lower the down payment.
44
What is one way to split the down payment to reduce risk?
Divide it into equity and debt.
45
In a preferred income deal, what should the buyer ensure regarding their partner's mindset?
The partner should feel they are winning at points in the negotiation.
46
What is the seller's motivation in a preferred income deal?
To receive cash upfront while retaining a stake in the property.
47
What is the interest rate proposed on the second mortgage in Example 7?
7 percent.
48
What additional incentive is offered to the seller if NOI exceeds $55,000?
An additional 2 percent interest on the unpaid balance.
49
What is the primary goal when negotiating a preferred deal?
To maximize return while reducing risk.
50
What is the purpose of splitting the down payment into equity and debt?
To manage risk while maintaining a return based on the total value of the property
## Footnote
This allows for the possibility of negotiating a second mortgage without affecting the yield.
51
What is an IRC 1031 exchange?
A tax-deferred exchange of like-kind properties, allowing sellers to defer capital gains taxes
## Footnote
This can benefit both the seller and the buyer in a transaction.
52
How can a yield be tied to a cost-of-living index?
By negotiating to adjust the yield based on the All Items Cost-of-Living Index
## Footnote
This allows the income from the investment to increase if the cost of living rises.
53
What additional collateral can a seller or partner provide?
Options include staying on the debt, assigning rents from other projects, or providing other property as security
## Footnote
This can help reduce risk for the investor.
54
What is a buyout provision?
A contractual clause that allows one party to buy out the other under specified conditions
## Footnote
Important to negotiate carefully as it can significantly impact the investment.
55
What is critical before seeking partners for a deal?
Having control over the transaction
## Footnote
This ensures you have a solid footing before looking for financial backing.
56
True or False: You cannot negotiate after tying up a deal.
False
## Footnote
There is still room to negotiate until the deal closes.
57
Why is knowing how far you can go with a deal important?
To avoid being outmaneuvered by more astute investors and to ensure the income projections are realistic
## Footnote
Understanding the deal dynamics is key for successful negotiations.
58
What does being flexible in negotiations allow for?
It increases the likelihood of making deals
## Footnote
Flexibility can help accommodate the needs of the other party.
59
What should you offer the other party in a negotiation?
An opportunity to be part of a beneficial deal
## Footnote
Positioning the offer positively can foster goodwill.
60
What are common pitfalls in preferred-income transactions?
Inaccurate income figures, narrow-minded competition analysis, overvalued property, excessive debt, incomplete due diligence
## Footnote
Awareness of these pitfalls can help mitigate risks.
61
Fill in the blank: An option is defined as a _______.
choice
## Footnote
In real estate, it specifically refers to the right to buy, sell, or dispose of property.
62
What is an example of an option to buy?
Paying a seller $5,000 for 12 months to buy a property at a specified price
## Footnote
If the option is not exercised, the buyer loses the option fee.
63
What is an option to lease?
A right to renew a lease under the same terms for an additional period
## Footnote
This provides security for the tenant while allowing the owner to retain control.
64
What is an option to lease?
A right to lease property for an additional term at the same terms as the original lease.
65
What is due diligence in real estate transactions?
A period for inspections and assessments before finalizing a purchase.
66
True or False: Due diligence is unnecessary for brand new properties.
False
67
What are the two basic kinds of options?
The straight option and the conditioned option.
68
What is a straight option?
An agreement that gives one party the right to buy or lease a property at a future date for an agreed price.
69
List examples of non-monetary considerations for an option.
* Buyer undertakes inspections
* Buyer verifies zoning
* Buyer leases with an option to buy
* Buyer creates a contract
* Buyer requests zoning changes
70
What is the role of the optionee in an option agreement?
The optionee is the person who holds the option and is in control of the agreement.
71
Fill in the blank: The option is primarily a tool for ______.
negotiation
72
What might happen if a buyer loses control of an option?
The buyer may have to scramble to regain their position or fight for their deposit.
73
What is a conditioned option?
An option that includes conditions which may cancel or alter the contract.
74
What is a key advantage of a conditioned option for the buyer?
It is the least risky option since it may allow for a refund of the option money under certain conditions.
75
List possible conditions in a conditional option.
* Soil test
* Survey certification
* Test holes
* Site plan approval
* Issuance of building permit
* Partner's approval
* Corporate ratification
* Obtaining satisfactory financing
* Government approval
* Prior sale of a third property
* Prior development of a section 1031 exchange
* Preleasing of to-be-developed space
* Environmental inspections
* Code and city ordinance review
76
What should a seller consider when negotiating an option?
The seller should ensure clarity on terms like option money application and buyer default conditions.
77
True or False: The option money is always sufficient compensation for the seller.
False
78
What can an option provide to a buyer regarding property trends?
An opportunity to build equity quickly while minimizing risk.
79
When should a buyer consider renegotiating an option?
When they have decided they want to buy the property and have leverage from their knowledge of the property.
80
What is the primary risk for sellers in a conditioned option?
The buyer can back out and receive a refund of the option money.
81
What is a conditioned option agreement?
An agreement where the buyer pays a fee for the right to purchase a property under certain conditions.
82
What is the purpose of a soil test condition in a real estate option agreement?
To ensure there are no subterranean issues that could increase building costs.
83
How much total option money is at risk after 13 months in the described scenario?
$30,000.
84
What is the timeframe for exercising the option after approving a soil test?
Nine months.
85
What is the total time frame to close the deal after exercising the option?
60 days.
86
True or False: The option money paid is applied to the sales price when closing the deal.
True.
87
What are the four key elements of an option in real estate?
* One-sided event granting control over a future event
* Psychological effect on sellers and buyers
* Usable by both buyers and sellers
* Represents a promise of a future event.
88
What is the primary purpose of the primary option transaction?
To keep financing costs low while allowing the buyer to delay the closing.
89
What is the option money paid for the feasibility study in the primary option scenario?
$50,000.
90
How long can a buyer tie up the property in the primary option scenario?
870 days.
91
What should always be included in a sale leaseback agreement?
An option to buy the property back.
92
Fill in the blank: The lessee has the option to purchase the subject property any time during the lease or its extensions for _______.
$1,000,000.
93
What is the first key element to include in an option contract?
Think beyond what you think you need.
94
How can an option be used as a negotiating tool in a lease agreement?
By asking for an option to buy the property at a predetermined price.
95
What should you watch out for when offered an option by a property owner?
Enticing offers like Shared Equity Transactions that may not be beneficial.
96
In a Shared Equity Transaction, what happens if the property is sold after five years?
The prospective buyer gets 50% of the net proceeds exceeding a specified amount.
97
What is the average return calculated for the investor in a Shared Equity Transaction?
12.94% per year.
98
What is the average annual return on an investment of $85,000 over five years with a total return of $140,000?
12.94 percent per year
## Footnote
This return is calculated as the simple average based on the total cash invested and unpaid interest.
99
How much remains to be split after an investor receives $140,000 from a total of $260,000?
$120,000
## Footnote
This amount is calculated as $260,000 - $140,000.
100
What percentage of the remaining $120,000 does the investor receive?
$60,000
## Footnote
The investor receives 50 percent of the remaining funds.
101
What should you know before entering into a lease with an option?
The actual values of the property
## Footnote
Understanding property values is crucial to assess the equity and potential value of the lease option.
102
What is a common strategy taught to real estate investors regarding shared equity plans?
Profit from increased property value from purchase to lease
## Footnote
This strategy emphasizes the potential profit based on property appreciation.
103
What types of mortgages might exist on a property purchased for $300,000?
First mortgage and second mortgage
## Footnote
An example includes a first mortgage of $225,000 and a second mortgage of $30,000.
104
What should you be cautious of when options are presented with unrealistic prices?
They may have no value to the deal
## Footnote
Such options can be seen as bait to attract you into the property.
105
What is one option you can negotiate for in a lease?
Option to extend your lease
## Footnote
This can involve a notice to the owner or a small payment to secure the extension.
106
What is another option that can be negotiated during the lease period?
Option to buy during the lease
## Footnote
This may include credit for some or all rent paid towards the purchase price.
107
What should options include to be effective?
Specific price or clear formula for establishing prices
## Footnote
This could involve a percentage of the cost of living or a specific index.
108
What is a first right of refusal?
An option triggered when the owner has a bona fide contract from another party
## Footnote
It allows you time to accept the same terms if desired.
109
True or False: You must exercise your option to buy or renew as stated in the contract.
False
## Footnote
The option only binds the other party to those terms, not the holder of the option.
110
What is an effective use of options when buying other properties?
Offer the same option to the seller of a property
## Footnote
This can provide leverage in negotiations.
111
What common desire do most sellers have in a real estate transaction?
To get the most out of the deal
## Footnote
This competitive nature can affect negotiations.
112
How can greed affect real estate transactions?
It can create conflict over who comes out on top
## Footnote
A focus on greed can hinder deal-making.
113
What is preferred income in the context of real estate transactions?
Protection, not extra money
## Footnote
It serves as a safeguard rather than a financial gain.
114
What is the best time to utilize an option in real estate?
When you know you are going to buy
## Footnote
This allows you to benefit from time without the expense of carrying the property.
115
Fill in the blank: The real estate game involves moving _______.
assets
## Footnote
This includes time and effort as commodities in transactions.
