Discount Purchases

by Mr. Cheap

In a recent comment, on a very old post (“5 Ways to Make (or lose) Money With Investment Properties – Part 5 – Buying at a Discount”), Awesome asks “i live in Toronto, how and where do I find the deals”.  I found this a perplexing question, as the assumption seems to be that there’s a website, or a very simple technique, which leads to low priced real estate.  The obvious follow up to this is you buy from the cheap market, sell on the regular market, then start lighting your cigars with $100 bills.  I pointed him to my posts on inefficient markets and Mike’s post on valuing real estate but never heard from him again (I guess he’s off searching for the “simple”, “easy” way).  I also told him that if someone knew where a deal was, they’d just do it themselves (and make the money themselves).  If they knew a good approach for consistently finding deals, they’ll execute that strategy themselves (and not make it harder by advertising it and drawing competition).  Between these three posts I felt like there’s still some missing information, so this post is my attempt to fill in that gap.

In “How to Buy Real Estate For At Least 20% Below Market Value” John Reed talks in the beginning about how he never saw a bargain purchase in his years as a real estate agent (not even 5% below market value).  At the time he thought they didn’t exist (and thought people who claimed they did were selling snake oil).  Once he looked into it, he found they did exist, just that they never showed up in the “official” (MLS) channels.

He summarizes the two ways to buy at a discount (for goods which are USUALLY traded on an efficient market):

  • properties which no one wants and
  • properties which no one knows are for sale

The impact of these principles is that you can’t buy ANY property at a discount (there’s no way to get a 20% discount on that cute little bungalow you have your heart set on), but you can buy MANY properties at a discount.  It’s like dating: if you’ve got your heart set on dating Mary Jones or Johnny Smith you’re sunk.  HOWEVER, if you just want to date someone (who meets some reasonable minimum criteria) there are ways to make it VERY LIKELY that you’ll be able to get dates.  Sadly (or happily), romance can be a numbers game.

One way to find deals is to hunt for desperate sellers (they’d fit into the “no one knows are for sale” category).  One approach to this is to make low-ball offers on many items, and try to find the person who needs to sell quickly (and can’t take the time to advertise properly and let all interested buyer know it’s available).  I detail this process in my “Shotgun Investing” post (and is also how I bought my investment condo).  I still giggle when I read Mike’s description of a “for sale by owner” sign (that might have been a big tip off that they’re desperate sellers)

Another way to find deals is to hunt for what Reed calls “leper properties”.  These are properties that have something about them that causes most buyers and agents to immediately dismiss it as a potential purchase.  Properties with foundation problems are an example of this.  I was suspicious that there might be an opportunity for buying co-ops (as opposed to condominiums) in Toronto because of this.  My agent told me not to even bother looking at co-ops, which IMMEDIATELY got my interest.  This is the “no one wants” category.

Obviously for a leper property you must have some way to fix the problem (for less that the amount of the discount), otherwise you’re just buying someone else’s problem.

In my home town (around the corner from my parents) there’s a property that at one time was the nicest in the neighbourhood.  It was on a double lot, and was far bigger than the properties around it.  The owners let it get really run down and then were trying to sell it.  It sat on the market for a LONG time, and EVERYONE in town had heard how run-down it was.  Eventually someone bought it, and immediately started a massive renovation.  I don’t know what the purchase price was, but they’re fools if they paid anything close to market (it was a property no one wanted).

Not Easy

One other factor with discount purchases is they aren’t as easy as buying on the market.  If you buy the typical way, everything is set up to make it as straightforward as possible.  As soon as you start buying in an unusual way (such as either of these approaches), the risk is going to go up and the difficulty is going to go up.  You’ll put time into a deal, then have it fall through at the last minute (or you’ll try 10 deals and have them all fall through).  Part of a reasonable approach to discount purchases is to be as efficient as possible in evaluating when a deal may occur, and dumping prospects IMMEDIATELY when it looks unlikely (so you can put your time into pursing a deal that has a higher chance of going through).  Many people don’t have the stomach for this (and will get angry if a deal doesn’t work out) and they’ll abandon their strategy because of the emotional toll.

Have you seen situations (real estate or other) where a good price has been had for one of these two reasons?

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{ 10 comments… read them below or add one }

1 Mike

My first house *sorta* fits into the “nobody wanted it” category – I bought it at the end of 1999 and it had sat on the market for 2 months. I don’t think it was a “deal” but the price seemed reasonable.
At the time interest rates had gone up a bit, maybe Y2K was a factor? The house wasn’t in great shape and same for the neighbourhood.
Things had completely turned around in 5 years – I only put about $20k into the house and there were 14 bidders.

Another example is timing – I know of one friend who bought a house that went on sale on Sept 10, 2001 (yes, the day before). I don’t think anybody was looking for a house for a while after 911 (except my friend) and I’m sure she got a good deal. Unfortunately her “super” agent choose to sell her house (a few years later) via auction over the July 1 holiday which is probably the worst time (other than Xmas) to sell a house in Canada. She told my friend not to worry about the timing since buyers are “motivated”. Yah, right.

2 Alexandra

My husband has gotten some super deals on real estate – I guess by buying from the “no one wants” category. Basically he spent a large amount of time looking at rental properties in Toronto with three units (usually in older homes) that needed some renovations but nothing major. He would then make a low offer – usually about 20% below asking price. Eventually someone would be tired of showing the place and having it listed, and would bargain with him (instead of just dismissing the offer outright, which was what a lot of people did). Two of our rental units were purchased this way, and have been very lucrative. You have to have a number in your head for what you are willing to pay and simply walk away if it goes over. No emotions whatsoever.

Our last house was also in the “no one wants it” category, but only because no one was able to look past it’s flaws and see the potential. Even our real estate agent who is used to seeing bad properties walked in, said “nothing to see here, let’s go” and almost walked out, but I would not let him. We had to level the floors (they were so uneven it gave you vertigo), knock down a few walls and float a staircase, and suddenly the place opened up and looked like a modern day loft. It only cost us $2oK to fix.

We sold it less than two years later for $150K more than what we bought it for. Cha-ching!

3 Mr. Cheap

Mike: Sweet! Sounds like you got lucky when you were buying and selling. I didn’t realize you’d put that much $$$ into your first house…

Alexandra: Your husband sounds like my kind of guy. I’ve done a fairly similar strategy, but found the angry sellers got me down. What was your husband’s “kill rate” (number of offers per successful purchase)?

4 Four Pillars

Well, $20k isn’t a whole lot (especially compared to my 2nd house). :) About $7k went for a complete new bathroom reno. $3k fixed up the electrical. The other $10k was just minor fixes/upgrades around the house over the 5 years.

5 Mr. Cheap

I put $6K into my condo, so it seems like a bit compared to that (but a house would definitely have more things to maintain). I also avoided bathroom / kitchen renos which would have upped the cost (although, interestingly, my parents just renovated their severely out-of-date kitchen for about $1,500 – so they probably think I spent too much :-) ).

6 Potato

I was surprised at how relatively cheap some Toronto co-ops were. One we saw actually had a decent rental yield of about 8.5% — it made me wonder if the rent they were asking was too high (or if there was some other issue with the building/neighbourhood). Turns out it was a co-op that required a 25% downpayment to buy in. Other co-op issues aside, that probably drove off a lot of potential buyers.

7 Mr. Cheap

Potato: Yes, that was one of the “problems” with co-ops that led to the low prices. The others were that the buildings often weren’t well maintained (they don’t have the same legal requirements for maintenance & a reserve fund condos do) and the co-op board can sometimes be autocratic (and may prevent you from renting it out)

In spite of these issues, as you say, if there’s a high rental yield that makes them enticing to buy as rentals. At the time I thought I could live with a 25% down payment if it meant I could pick up some property cheaper.

(I also thought an interesting business might be to offer financing on better terms to people buying co-ops).

8 Alexandra

I’ve never heard of “kill-rate” before – cool term. I’m not sure on the exact number, but in each case it took several months of searching, offering and turn-downs before a fish bit. It never got him down though – he knew that most people selling also had their own “number” in their head that they would not sell for less then. The trick was to wait for that guy who was just sick of the game and wanted to unload, even if it meant giving the place away for less than he thought he would get for it.

Yeah, a few people were insulted by the low offers, but in this game you can’t afford to be swayed by other people’s emotions.

9 Marina

I have bought two places and both were of the “no one wants them” variety. Both were bought during down times in the market and were not aesthetically ideal.

The first was a bungalow that had been converted to three apartments. It was in great condition but the decor was pure 1970s. It had already been reduced from $119K to $109K (this was early 1990s, and Montreal, not Toronto), I offered $87K and got it for $92K. It has been rented out pretty steadily ever since, with upgrades made when needed (one kitchen is still pretty much 1970s, but my long-term tenant is not complaining yet).

The second was a co-op bought in 1998. I had seen one-bedrooms for between $65K-$85K (one in the same building, again this is in Montreal) and saw an ad for a 2-bedroom asking $52K. I went to the open house and saw people turning away without even walking through the door. The place had not been lived in in 8 years, had wall-to-wall green shag carpeting from the 70s and the original kitchen and bathroom from the 1940s, it was a disaster. I offered $45K and got it, gutted the kitchen and bath, put about $20K in to redo those, refinish the hardwood floors, and repaint and had a great place to live for the next ten years.

I definitely recommend this strategy if you have the patience and the vision. I am living in Toronto now and am hoping to be able to find a similar deal here.

10 Mr. Cheap

Marina: Good luck for your hunt in Toronto! It’s interesting that after you’d paid reno costs on your second buy, it was the same price as the low end of the market range you’d seen (I hope its condition was more like units from the high end though!).

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