Apartment Buildings

The White Hat Commercial Broker

Just about a year ago I read a book by Robert Ringer called “Winning Through Intimidation”. It was a spectacular book with a spectacular – and completely not-politically-correct – title.

The interesting thing about it was that it really wasn’t about intimidation at all. No, it’s central thesis is that in any business deal the smart businessman will do the upfront preparation, and put in place the necessary safeguards, to protect his position at all costs. The reason? Ringer believes that every person that you do business with falls into one of three categories of people that all have one thing in common – they all want to cheat you, and they will if you give them the slightest chance.

I bring this up because I found his three categories interesting, and as I have wound my way through the maze of the real estate business I have been on the lookout for each of the types. And I found one a couple of weeks ago.

I found a real-live Type Two. Also known as a “White Hat”.

What’s a Type Two?

Ringer describes a Type Two as “just plain treacherous”. And “hard to recognize and extremely difficult to handle.” He states that their modus operandi includes using words like integrity, honesty, and ethics in abundance, and piously looking down on competitors and colleagues alike as unscrupulous.

This Type Two happened to be another commercial real estate broker – one of the few that regularly runs ads in the Sunday Detroit News and Free Press classifieds for apartment buildings. I called him as part of the research and ramp up that I was doing on my Apartment Quest, and he said that he had “the perfect building” for “someone just starting out.” I took the bait, and made an appointment to sit down with him.

The meeting in his office was pleasant enough. He spent the first 35 minutes or so extolling the virtues of his business. Telling me how he only deals with the best properties, how he won’t even list, much less sell, a building that won’t cash flow on Day One. How he takes great pains to dig into the financials of every building and price each one within a whisker of what it should ultimately sell for. And he also told me that I shouldn’t be “all that concerned” with cap rates, as they’re “only rough guidelines of value”. (Hmm. That sounded familiar. But I didn’t put 2 and 2 together at that point and realize that he was a Type Two.)

And he finished up his soliloquy by describing all of the charitable things that he was involved with outside the office.

Then he presented The Building to me. It really was a nice building, right in my area of focus in the east side suburb that I target. It was smaller that I would have liked, but he billed it as a totally hands off property that would run itself once I bought it.

Then he presented the numbers, and that’s when (the first) red flags started to go up. He was billing this as an 8 cap rate building, but he was using the current property taxes, “pro-forma” rents because “they are under market and you can raise them”, and no repairs or maintenance, “because the owner does all of the work himself”.

While this certainly wasn’t what I expected from a broker that “dug deep into the financials” of every building that he listed, I decided to take a look at it because it was close to a building that I was already making an offer on, and because he said that the buyer was “motivated” and wanted to trade up to a larger building.

I saw it and liked it, but when I ran the numbers it was clear that the asking price was almost 25% too high for it to be an 8 cap rate. So I worked up and offer and faxed over a Letter of Intent. That’s where the fun began. I offered the seller a true 8 cap rate, and I asked that he take back a 10% second mortgage.

When he called me to “review” my offer, he began by “quoting” the IRS tax code (???). He told me that the IRS has strict guidelines about interest rates on private mortgages, and that my offer of a 5.5% interest rate on the seller financing piece would subject the seller to imputed interest and other unfavorable IRS scrutiny. That didn’t sound accurate, but I didn’t know for certain. He also told me that I shouldn’t include the new property tax rate, “because I can always petition to have it lowered”. We talked for a few minutes more, and he tried to convince me that I should revise my offer upward due to these factors and resubmit. I declined and directed him to present it as written.

While I was waiting to hear back I did some research on the tax code. It turns out while there are strict IRS guidelines on these interest rates, they don’t kick in until you are in the area of 4.3%. Far below where I was offering. This guy had told me an outright lie to try and get me to offer more. ( Yeah I know – a commercial broker that lies – call 60 minutes)

A week passed and I hadn’t heard back on my offer so I rescinded it. The broker called to discuss it, and said that he in fact had run my offer by the seller, but that it had been “far too low” and that the seller was “talking to other interested buyers”, but if I was still interested, he thought that he could persuade the owner to come down on the price about 5%, but that was it. I worked the numbers and quickly realized that at that price it was – get this – a 6.2 cap rate. And at that price it had a negative cash flow with a 20% commercial mortgage.

I sent him the numbers that I used to do my analysis and asked what part of it was incorrect – and he didn’t have an answer. I then asked about his pledge not to sell buildings that didn’t cash flow – and he didn’t have an answer. But he did go on and on and on about what a nice building it was, and what good condition it was in, and what great pride of ownership it showed, blah blah blah blah. All the stuff that didn’t mean anything in terms of ROI.

So “Mr Integrity” was really Mr White Hat. He’s called me a couple of times since to try and get to “a meeting of the minds”. I declined.

 

I recommend Ringer’s book – it’s a good read but in it he comes across as an angry guy with a massive inferiority complex. He also sold out to the PC crowd on the second edition. He apparently got a lot of flack for the title, so he sold out and changed the title to “To Be or Not to Be Intimidated?: That is the Question”.

 

Check back soon for the next installment – The FSBO Building.

 

About Dennis Fassett

I'm pleased to report that after multiple decades of hard-headed stubbornness, I've finally figured out that all work and no play makes Johnny a dull boy. So I've taken it upon myself to convert my wife and now adult(ish) kids into a roving band of merry adventurers. From horseback riding in Monument Valley to ocean kayaking in Acadia - all of our exploits have earned the coveted "epic" label from the younguns. I'll tell you about them - and also about the other "adventures" I'm having in my real estate investing business.
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