There is no question that having a strike price is an invaluable tool not only when it comes to real estate investing, but with any sort of large purchase. After all, there's a reason auctioneers talk so fast. As Slate pointed out, the speed is "intended to give the buyers a sense of urgency: bid now or lose out." But as any decent real estate investor knows, not buying a deal does not mean you "lose out."
Having a strike price (a price that's the highest you're willing to pay) ahead of time is what prevents us from getting carried away in the competition of an auction or negotiation. It prevents us from confusing buying a property with winning. Oftentimes, buying a property means you lose. So never go into a real estate negotiation without a strike price.
But that being said, there is a downside to the strike price. It can subconsciously become the goal to aim for that could prevent you from doing even better.
Aiming for the strike price
Not too long ago, I was trying to negotiate the purchase of an apartment complex and had done pretty well up front. I had met the seller at the property and asked all the questions I needed to know in order to make an educated decision. I had spent two hours there, just talking with the seller and building rapport. I had also collected all the necessary documents, such as the profit and loss statement and rent roll.
I then went back and crunched the numbers. I came up with an offer price and a strike price. It looked like this:
- List Price: $795,000
- Offer Price: $690,000
- Strike Price: $725,000
I still had a few questions to answer, and I figured the best way to do this would be to go over the deal face-to-face (especially since there was no agent involved). Face-to-face negotiations are usually the best, as they allow you to tailor your approach to the individual seller instead of just being another justification-lacking offer, bound to get lost in the netherworld of someone's email inbox.
So I invited the seller to our office, and we again talked for about an hour before negotiating anything (he's a bit of a talker if you haven't figured that out yet). I then went over my questions to make sure my assumptions still held. Then I made my case: I explained that I took his numbers from 2014, then plugged in a few more (such as a management fee) and also increased a few things (such as utilities because the property would operate at a higher occupancy and some of the utilities are paid for by the owner). I then said we needed to hit a certain cap rate, and that would put us at $690,000.
He responded by saying that was way too low. I didn't flinch. Instead, I leaned forward and asked, "So at what price would you be willing to sign a contract today?"
Then I paused.
So far I had done pretty well. You can argue that I should have asked for a reduction before making my offer, but I think it's often better to justify your price first. It's a process called "framing," which I will write an article on in the future. But it works similarly to anchoring, or setting the ballpark of the negotiation, which I discuss in more detail here and here.
Either way, I then made a mistake. He came back at $740,000. That's a substantial drop. But instead of thinking "What's the best deal I can get?" I had the strike price stuck in mind. I came up all the way to $715,000, thinking (or maybe not thinking) we could meet in the middle at $725,000. In my defense, I knew as soon as the words left my mouth that I had come up too much. But the reason I came up so much wasn't temporary insanity or bad negotiating skills (well, that's debatable, I guess), but simply that I had that strike price stuck in my mind as the goal.
What I should have done is pause again. Go back to my analysis and explain why it would be tough to go over $700,000. Maybe he would come down a little more before I even countered. If not, I could come back at "an even $700,000″ or something like that. Maybe I could get him down to $715,000 or $710,000. Instead, I left money on the table of the sacred strike price.
Aiming for the goal price
That's not to say this negotiation was a disaster. We went under contract at the price I wanted to get the property for: $725,000. However, upon reflection, I knew that I had not only done something wrong, but was also going about things wrong in a structural way. I was putting way too much emphasis on the strike price.
Remember what a strike price is; it's the highest price you're willing to pay for a property. What it is not is the price you want to pay for the property.
So I've added a number. I still have an offer price and a strike price, but I also have a goal price. The goal price is the price I really want to get the property for. In other words, the goal price is what you're aiming for and the strike price is what you will settle for. Looking at it this way can even make you reconsider your offer price. "Am I leaving too much on the table?" After all, had I offered $675,000, the seller probably would have still come back at $740,000, maybe even a little less since I anchored the price lower. You want to find the lowest offer price that isn't so low as to offend the seller. I doubt an extra $15,000 would have done that.
So if I had another chance at the above situation, I would have probably come up with the following:
- List Price: $795,000
- Offer Price: $675,000
- Goal Price: $700,000
- Strike Price: $725,000
Would it have worked out better? There's no way to know. But what I can say with a lot of confidence is that the strike price should not be something to aim for; it should be something to settle for. You should always try to do better. Our subconscious minds will aim for the price you set ahead of time. So why not set a lower price to aim for and if you can't get there, then settle for the strike price? That way, you won't let your subconscious mind leave money on the table.
This article originally appeared on Bigger Pockets and is Copyright 2014 BiggerPockets,