I wrote an earlier post on negotiating, stressing the idea that investors should negotiate based on principles instead of trying to defend established positions. What do I mean by this? I mean that if you negotiate based on a position (example: I'll pay $100 thousand and not a penny more) then you'll end up digging your heels in on something that may not be the only path to getting to the principle that's really at the core of your best interests (perhaps the seller could offer seller financing? Or give a package discount on the neighboring plot?)
So here's a couple of case studies. These are actual situations that I have found myself in - slightly stylized for confidentiality purposes.
Situation A: New tenant applicant with shaky credit
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Scenario:
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I had a vacancy coming up on a single family home, and a family who was interested in occupying the property. They were great candidates, interviewed well, and had decent employer references. The problem: shaky credit. The applicant did not appear to be habitual non-payers, but evidently had experienced some events that had damaged their credit score. |
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Potential Positions:
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Negotiating to defend a position is a trap that can limit creativity.
I never rent to tenants with a credit score below____.
I only sign leases of one year or longer.
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Principle at stake:
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I want to minimize vacancies, maximize cashflow, and take risks that are proportionate with the potential rewards. |
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Solution:
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There are many solutions, of course, but here's what I did:
My gut told me that this applicant might make a fine tenant. So I set the rent at the higher end of the market range and signed a six month lease. I required the tenant to pay the first and last month in advance, plus one month’s rent as deposit.
This decreases the risk of the deal in a few of ways.
- Two of the six months are pre-paid. I remained exposed on the middle four months, but this is a significantly lower risk than a standard one-year contract in which the tenant only pays the first month rent (plus deposit) at signing.
- The new tenant’s ability to produce three months rent (two months plus deposit) as a lump sum before they moved in increased my confidence that they had their financial situation under control.
- No tenant wants to move in, stick around for six months, then move out. I clearly stated that the six month term was a probation period, and I spelled out in the lease that I would sign a one year extension if they made all payments on time during the first six months. This clearly sets expectations and aligns the parties.
Outcome: good cashflow, two months rent upfront, motivated tenant, well-defined exit strategy if things don’t go as planned.
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Situation B: Tenant who is unsure about renewing lease
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Scenario:
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I had a solid tenant who, at renewal time, was thinking about possibly moving out and buying a property at some time in the near future. The tenant didn’t want to sign a one year lease and asked me to sign a six month lease instead. |
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Potential Positions:
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I only sign leases of one year or longer.
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Principle at stake:
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I want to minimize vacancies, reduce turnover, and minimize the amount of time and effort that I spend negotiating with tenants. Meaning: I don't want to go through this every six months. |
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Solution:
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I agreed to a six month lease, but I changed the terms of the lease as follows:
- If no notice of termination was submitted by either side, instead of renewing on a rolling month-to-month basis, the new contract stipulated that at the end of the period the contract would renew for another six months, and that the rent would increase by 2.5% at each renewal.
Outcome: I reasoned that it was possible that the tenant would leave at the end of the term, but in this case it was more likely that he’d stick around for a while. I didn’t want to be schlepping over there to start this negotiation all over again in six months, especially with regards to rent increases.
With this tweak to the contract I created a solution which would allow the tenant to stay as long as he liked (subject to either of us terminating) and hardwired a 5% annual rent increase.
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Next, I'll talk about generating creative options - a key tool that you need to have in your back pocket when going into a negotiation.
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