Commercial Real Estate Mastery: Episode 27
How To Negotiate
No industry has more reliance on the simply act of negotiation – yet few Americans are well versed in the fundamentals of this skill. In this Commercial Real Estate Mastery podcast we’re going to review the art of negotiation and how understanding its methods can lead to better end results.
Episode 27: How To Negotiate Transcript
One of the most important skills in all of commercial real estate is the art of negotiation. Yet the problem is that's one skill that most Americans are lacking or definitely need some tips on the technical parts of that endeavor.
This is Frank Rolfe with the Commercial Real Estate Mastery podcast. We're gonna talk about how to negotiate.
Now, our early forefathers, way, way, way back, even a thousand years ago, they were much more adroit at negotiation because that was part of the world back in the days before published prices and the internet. None of us really knew what anything was worth, and we were always trying to buy things with the least amount of money, and the sellers always wanted the most amount of money. So people just learned at an early age how to negotiate. And in some countries other than America, negotiation is still a big part of their culture. They negotiate things constantly. Areas where people buy products in a central market, where they go in, where there's all kinds of things, there's food products, clothing products. They're very used to going in and negotiating to get the best deal. But here in America, typically we don't have that skill anymore. We've lost that because everything is very clearly priced. And a lot of stores, obviously, they don't negotiate. And store clerks, they can't negotiate. They have no power. So as a result, we all kind of got a little rusty on that skill. But the problem is in real estate, you have to have that skill. It's not something that you can avoid and succeed at.
Even Warren Buffett, who was America's greatest stock investor, I say was at this point because he is now retired from any management role at Berkshire Hathaway. But he said later on in his career, the guy's in his 90s, that the reason he worked on stocks and not real estate was he didn't have any skills in negotiation. He liked the fact that when you buy a stock, the price is right there on the computer screen and you can either buy or sell. But he wasn't any good at negotiation, so he didn't feel like he would really be a good player trying to buy and sell real estate. But the problem is that a lot of the best money out there today in investments and in creating wealth comes from real estate. So you've gotta learn how to negotiate.
So here's what we know about negotiation. Number one, let's look at how it works from the buyer side. When you're trying to buy a piece of real estate, what's critical is that first offer. You have to offer the least possible amount you can get a counter on, because if you throw out a ridiculously low price, the seller will never counter that price and you have a zero percent chance of success. So that isn't gonna work. Throwing out ridiculously low prices has never been a successful strategy. So then what do we do instead of that? Well, we have to put enough thought in to figure out how low can I go, yet my offer is still close enough to the target that the seller will say, "Okay, well," and then they'll counter with a different price.
So I've gotta put a little research in. I've gotta have the knowledge of what I'm looking at doing enough to know what that should be. And typically in real estate, the valuation we use on properties is based on what's called the cap rate, the capitalization rate. It's the net income of the property divided by the total cost. And we have found historically, over decades of being in the commercial real estate business, that the cap rate that will typically elicit at least a counter is about a 12% cap rate. So if you can figure out what the net income stream is, you can figure out a price that yields a roughly 12% cap rate. And using that as a first offer, our studies have found that will more than likely get the seller to then counter.
But when they do counter, what happens? So you throw out a price that's based on a 12% cap rate, and they throw out their price based on a 6% cap rate. Well, that's twice as much as what you're probably looking to pay on the front end. So how does that then work? Well, you've got to counter again. But before you throw out your price, you in fact gotta do what they call the flinch. Now, what the flinch is, it's kind of Hollywood theatrics. What it means is you give the feeling like the price they just threw out is abnormally high, just scary high, crazy high. So you would say something like, "Oh, man. Okay, that's a lot." Because in the world of negotiation, part of what we're doing is making the seller feel as though they are taking advantage of us, because that makes them feel good about their negotiation skill. So negotiation is an unusual thing, right? Because what we're trying to do is get what we want, but at the same time make the other person feel good. So to do that, you have to have the flinch. No matter what price they throw back at you, you have to flinch and say, "Oh, gosh. Man, you drive a hard bargain. Okay, well, how about this price?" And like tennis, you go back and forth and back and forth with the price, you throwing out things that are always low as the buyer and they throwing out things that are always high as the seller. And then you bounce back and forth, and you typically end up splitting the difference, often is where it ends up. So if I started off proposing to buy a property at a 12 cap and they countered with a 6, we're probably gonna end up somewhere maybe like around an 8, maybe a 9, something in that arena.
Now, if you want to see this in practice every day, it's super easy. If you just watch the shows American Pickers or Pawn Stars, those shows are nothing but nonstop negotiation for the full 30 minutes or one hour that the segment lasts. You'll see this happen over and over and over. The buyer starts low, the seller counters high, there's a flinch in between each pricing arrangement, and then finally they meet in the middle. And that's kind of how negotiation works.
However, there are a few other fine points you have to know on that. It's very important to know what the maximum price is that you can pay, because you're never gonna get anywhere in negotiation unless you actually have a ceiling as to what the amount will be that you will go with. Because typically when you reach an impasse, the other party has to then either lose the deal entirely or go to whatever that number may be. And so that's a critical item. So if you watch an episode, for example, of American Pickers, let's say there's an old metal Coca-Cola sign on the side of a barn. And the American Pickers guys, which are antique pickers that buy things and sell them in their store, they go to the farmer and say, "Hey, I see that Coke sign on the side of your barn. Would you sell that to me?" "Well, I don't know. What would you give me?" "Well, how about $200?" "Oh, no, no, no. That's crazy. Maybe 800." "Oh, 800. That's crazy. I can't even sell that for 800 in my store. How about 300?" "Well, I could maybe come down to 700." "Oh, gosh, no. 700, that's really way, way too high still. How about 300?" "Well, let's see. 300's crazy low. I could maybe go down to 500." "Okay, well, how about 400?" "No, it has to be 500." "How about 420?" "No, if it's not 500, forget it. I'll just leave it on the wall." And the buyer then says, "Okay, I'll go with 500." Because whenever a party reaches their limitation, the other party typically responds to that, if they want to get a deal done, by meeting at that price. So once again, kind of like with the going-in offer in negotiation, you have to have that maximum amount in mind, too.
The bottom line is, in correct negotiation in real estate, the buyer has to have done their homework in advance of the meeting. Because you're supposed to be coming to a conclusion of a price that meets both parties. But the seller, they already know the value because they know how much money it produces, and they probably have had other offers in the past. But the buyer, they have no idea. And that's why if you want to be a really good negotiator, there is some degree of homework required before the negotiation begins. You can read books like there's Trump's book Art of the Deal, which has a lot of negotiation in it. But the problem on that book is a lot of it is what's called win-lose negotiation. That's where one party walks away from the transaction unhappy and the other one feeling highly successful. Most of commercial real estate successful negotiations come from what is called a win-win transaction. A win-win transaction is where both parties walk away feeling good about the end result. And to get to that level, you have to do two things. One, you have to do your homework and knowing your valuations. But the other is you have to be a good negotiator and you have to affirm to the other party that they are also a good negotiator by playing the negotiation game.
I was once working on a property and a seller threw out a crazy low number, crazy low, far, far lower than anything I would have ever imagined. And I could have said, "Oh, I'll take it." That would have been bad. But instead I acted pained, like, "Oh my gosh, that's such a high price." And then I countered back, even though it defied common logic, because the price was in fact too cheap. But the problem would have been if I said, "Okay, I'll take it," they would have always felt forever unhappy that clearly they had priced it too low, and it would not have been a true win-win deal because they would have walked away from the transaction feeling cheated. They might have even retracted the number. So it's very, very important that all of us always understand and remind ourselves negotiation, in fact, is an important part of the relationship between two parties when trying to derive a price.
This is Frank Rolfe, the Commercial Real Estate Mastery Podcast. Hope you enjoyed this. Talk to you again soon.
