Deal considerations

Purchase price really determines your profit or return potential, because if you get the purchase price wrong and for example, if you overpay, there’s going to be very little that you can do during the investment to really get what you could have gotten from the investment.

So determining the right purchase price is critical because it can’t be too high or you would miss out on returns. But if you make it too low or offer too low, you may never have gotten to acquire the property in the first place.

Now, another consideration related to the purchase price that often affects an investment is called contingencies. These apply more often in commercial investments, for example, if you’re buying a warehouse where there were some industrial uses before. And there is a huge risk of environmental contamination that may involve some very, very costly cleanups, if that’s the case and there aren’t any other sellers, your buyers that you’re competing with, you may be able to negotiate a contingency in your purchase that says to the buyer, hey, I’m going to pay this price. But if there’s something wrong in terms of environmental rules and I have to spend money to clean it up, you agree to spend money to pay for that?

And these contingencies could be done in such a way where a portion of the purchase price is held in escrow for a period of time, maybe up to a year or so until those other issues are confirmed or verified to be addressed or to be nonissues. So there are different ways where the purchase price could actually be adjusted.

So contingencies are one of them that can, in fact, impact or protect your returns.

Now, the other thing are some other special provisions that could be related to purchase price, and one of the examples would be something like an or now.

And this is very common or not that common, but this applies more to operating assets or assets where you have operations and earnings are a way for a buyer who wants to buy an asset and wants to operate it and thinks they can do it better than the previous owner.

The desire to be able to get the asset without having to put as much cash up front and earn outs is a way to say to the seller, hey, let me pay for a portion of the purchase amount by giving you some ownership in the profits of the business after you sell it to me.

And this can be a win-win type of scenario where the buyer is able to get it without having to borrow as much money or put as much money into getting the asset and the seller.

If they’re confident that the buyer is able to execute and earn more profits from the property and get more out of it than they could, then they have the potential to earn more out of that sale over time than if they were just to take it as a one time transaction. So with respect to purchase prices, they’re actually quite a few things that could actually impact the ultimate purchase price, things that would adjust it right.

Whether there are contingencies or else that would make it different from what you ultimately pay and it could impact your returns.

The second deal-related consideration is rehab.

It’s basically, well, deciding what exactly are you going to rehab or renovate?

How much are you going to spend on it?

How long is it going to take and whether you’re going to get financing around that?

Because if you end up spending more than what you plan and if you end up taking much longer than what you plan in order to do the rehab, your returns for the investment are not going to be as good as you plan.

It’s going to be lower than what you plan, both in terms of the cash multiple and the IRR, which you’re going to learn about later.

How much you’re going to spend, how long it’s going to take and exactly what you’re going to do is going to impact your investment analysis, and that’s part of the homework that you have to do as an investor before you really commit to buying it.

You’ve got to decide what exactly you’re going to do with it.

So when you’re, for example, when you’re looking at a fix and flip investment, you don’t just go buy it and then later decide what you’re going to do to it, how much you’re going to spend and how long it’s going to take.

When you’re looking at it, you’ve got to decide what it needs as part of your analysis.

You’re going to go to the property.

You’re going to take a story and decide that the kitchen is fine, but the bathroom needs to be renovated and it needs to be repainted outside. You can decide on those things and then get a quote on the costs around that and how long it would take. So then you can factor all of that into your analysis.

Using your analysis can give you as accurate a portrayal of what you’re going to get out of that investment as possible.

The third thing is related to capitalization, and that really just has to do with are you going to have investors, are you going to take on some debt as well as equity investments, or are you doing it all by yourself?

If it comes from investors or it’s coming from banks, it’s going to cost you and what are you going to use it for?

So when we talked about the renovations, well, there are other uses of the funds because maybe this is something where you’re building brand new apartments and you need some funds to market the asset.

You’ve got to pay for a bunch of things before you actually get enough tenants in the apartment.

So knowing what you need for and exactly how you’re going to spend it as well as where you’re going to get it from, all of those will impact your investment analysis because of where the investors are coming from and if investors are coming in and how the banks are coming in will affect how and when you get your returns.

And that’s part of what’s called the distribution priority.

For example, if you’re taking a lot of investments from investors, you don’t have a lot of money, but you know how to put a deal together and you get investors to invest 90 percent of the cost of the investment.

They’re going to have some priority on the profits that are coming in.

And you’re going to have to return a certain amount of profits to them before you will see any kind of bonus for the hard work that you put in. And that’s what’s called the distribution priority, and the way that is usually handled is through something called the Waterfall Framework.

The next thing related to deal considerations is not specifically part of the deal, but I put it here because it really does impact your investment analysis or specifically whether there’s a good fit between the project and the investors involved, yourself included, which is the return expectations.

So if an investor is expecting to get high profits, really, really high profits and really high returns, then it wouldn’t be a good fit for them to invest in a very safe investment where they’re collecting five or seven percent returns.

So there’s got to be a good fit between the investor and the type of investment, because when your return expectations as an investor are very clear, it does two things that allow you to be more efficient in evaluating investment opportunities.

It will narrow down the choices or investments that you should be looking at, the types of investments, and the type of assets, and also narrow down the markets that you should look into because it’s easier to look at ones once you have a clear idea of what your expectations are. If you’re expecting really high returns, you’re going to have to look at riskier types of projects in more opportunistic or growth markets.

But if you’re looking for something very safe and very low risk, then you can look at more income producing properties, properties that are brand new properties that have tenants already there on long leases and in very core markets that aren’t likely to have as much market risk as some of the newer markets.

Timing with respect to return expectations is when do you expect to get your money or profits back? So an investor that is looking to invest and wants to get their money back within six months.

That wouldn’t be a good fit for an investment where you really need to hold it for seven to 10 years to see the full returns, where that project is really betting on some appreciation in the market. So when you expect your returns to come, will also impact the return expectations and ultimately what kind of projects you should look at.