Magazine 05 - How To Negotiate Contract

The toughest aspects of investing in self storage is negotiating contracts. Coming to an agreement between two parties despite conflicting economic factors is difficult. The buyer thinks the price is too high while the seller thinks it is too low. The ideal scenario is everyone walks out feeling that they have accomplished what they wanted. As much as possible, you want every negotiation to be a win-win.
The world of real estate and especially self-storage is very small. People talk and the last thing you want is a bad reputation and no one even considers doing a deal with you.
Avoid wasting time and energy with letters of intent. There is a very good reason for this.
The seller in the negotiation will end up shopping the offer against other potential buyers. This can be time-consuming and simply delay the entire process. And worse, you could end up in an auction where you are bidding against another investor. Skip the letter of intent and move immediately with a contract.
Fernando O. Angelucci is Founder and President of Titan Wealth Group. He also leads the firm’s finance and acquisitions departments. Fernando Angelucci and Steven Wear founded Titan Wealth Group in 2015, and under his leadership, the firm’s revenue has grown over 100% year over year.
Find out more at
https://www.TheStorageStud.com


http://titanwealthgroup.com/
Titan Wealth Group operates nationwide sourcing off market investment properties for Titan Wealth Group’s acquisition as well as servicing a network of thousands of active real estate investors world wide. Prior to founding Titan Wealth Group, Fernando worked for Dow Chemical, a Fortune 50 company, rolling out a flagship product estimated to gross $1B in global revenues.
With an engineering background, Fernando is able to approach real estate investing with a keen analytical mindset that allows Titan Wealth Group to identify opportunities and project accurate pictures of future performance.
Fernando graduated from the University of Illinois at Urbana-Champaign with a B.A. degree in Technical Systems Management.
Titan Wealth Group was founded in 2015 with the vision of gathering individual investors that have the means to invest but lack either the time to find high-yield investment opportunities or the access to these off-market deals. All too often, founders Fernando Angelucci & Steven Wear came across investors who had deployed their capital only to regret the lack of consistency or degree of returns their investments were producing. In response, Titan Wealth Group provides access to highly-vetted real estate secured investments and off-market acquisition opportunities primarily in the Greater Chicago MSA. Today, Titan Wealth Group not only assists individual investors but has grown to support the acquisition goals and capital deployment of investment groups, private equity firms, and real estate investment trusts (REITs).
As a facilitator of wealth growth, Titan Wealth Group believes that success is not limited to the sum of our efforts and is infinite with what can be accomplished through partnership.
#SelfStorage #RealEstateInvesting #AlternativeFunds

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So how do we negotiate contracts? This is a very interesting topic it's near and dear to my heart. I'm a big fan of sales psychology. I really do love to negotiate because the way that I look at negotiation is not a you versus me, but it's you and me versus the economic factors, the world, what's going on out there in the market. So how do we come to terms that we can both feel like we've accomplished what we wanted? We both can walk away from the table feeling like we've got a good deal and you know, it lasting all the way through the due diligence period and the inspections and the closing.

So one of the very first things that we do is we usually don't waste time with letters of intent. Letters of intent. The fact that it was a nonbinding offer to purchase real estate. What I have found is that this is usually a waste of time. It usually allows the seller to shop your offer against other offers before you actually have the property under contract and be able to get their other competitors as well. So we usually will skip over the letter of intent and immediately go towards contract. But before we do that, we've got to make sure that we're doing our proper due diligence.

So what we'll do is we'll send over a needs list or a due diligence documents list to the seller and say, Hey, here is a list of maybe 28 things that we need from you. We understand that you may not have all of them, but everything that you do have, if you can send those over to us, that will allow us to structure an offer that is accurate for you. The last thing that we want to do is a seller giving us false information, either knowingly or not knowingly, and then us going under contract, and then, you know, a month or two months down the line, we find out that the numbers were inaccurate and then we have to adjust our contract.

Nobody likes to do that. It always feels kind of like a blow in the stomach. But it really comes, you know, the more open you are with the counter party, the easier it is to get transactions done in a fast and seamless nature. So we'll ask for all those due diligence documents. And those due diligence documents, not only did we send them over in a list, but once we go to contract, we'll actually include all of those documents named in the purchase of the units. To state, Hey, you know, our due diligence period does not start until you have provided all of these documents because the last thing we want is, you know, we go through the whole process where a day I had a closing and then the bank still hasn't received the seller's tax returns. And then all of a sudden the tax returns come back and show that, you know, he's reporting half the amount of income than what he or she claimed they were intaking from their facility.

And again, now, not only are we not able to buy at that price, but the bank won't even lend on the facility at that price, given the information that we receive. So what happens is in our negotiations, in our contract negotiations, the very first thing that we'll ask for is a set of due diligence documents and our due diligence period, which is usually 30 to 45 days, depending on the size of the facility or the land or the real estate, the subject property. That due diligence period does not start until we have all the documents we need to make an informed decision.

Now, some sellers are uncomfortable sending these documents before having a signed purchase agreement, which I totally understand. So we always tell them up front, there's two ways we can do this. There is you can give us your numbers verbally without providing any, any documents. And if they're accurate compared to the due diligence documents, we get later on, you know, we can put your property under contract at a price that makes sense based off of what you told us. And then if they're accurate later on, then the price stays the same. But if they are not accurate compared to say your tax returns or your profit and loss statement signed by your CPAs, then we will have to adjust the price down. Or what you can do is you can send us all these due diligence documents right now. Then when we go under contract, that price that we have is going to be unchanging. And the due diligence period will start immediately because the second we go under contract, you already have given us all the documents required. So that's one of the very first things that we do.

Another thing that we also do is that we also request the ability to extend our due diligence period or extend our closing period by offering additional earnest money. Now, earnest money is a sign of good faith that you're going to close on a facility. You're not just going to tie them up and then walk away at the end. So there's a penalty for us as buyers. Say that we get through the due diligence period and there was no objections. But then when we go to closing, we're unable to close for whatever reason or the closing timeline doesn't work for us. If we try to cancel that contract, the seller gets to keep our earnest money or our good faith money. So one of the things that we always negotiating these contracts, because, you know, these are not small facilities that we're purchasing on the low side. You're looking at, you know, maybe 800,000 on the high side, you're looking at $12million to $15 million properties. You know, we're putting down $15,000, $25,000, $50,000 in earnest money to show that we're serious and we don't want to lose that.

So if there is some external force that causes the transaction to be delayed, we'll actually ask for extensions. And the way that we after these extensions is by offering up additional earnest money. Say, I would like to purchase another 30 days of closing timeline for an additional say, $15,000 or $25,000 in earnest money. That shows that, Hey, we're serious. We're not just dragging this out. There is an end in sight. There's a goal in sight. And to prove that, we're willing to give you more of our money to put at risk in case we don't close.

Now, another thing that we always push for in our contracts, and this is a nonnegotiable item, is environmental issues. We will get a phase one environmental report. Now what a phase one environmental report is, is you hire an environmental engineering company and they will look through all the records that ever have been produced from the EPA or from local municipalities, anything having to do with environmental concerns. And they'll go through all of these documents. They'll visit the site, they'll look for any type of issues that may be around. Maybe there's a gas station on the corner that is leaking hydrocarbons. Or maybe the site, you know, maybe we're buying a warehouse to convert to self storage. And it turns out 80 years ago, this warehouse was used to make really nasty industrial chemicals. These are all things we have to be very concerned about because when it comes to environmental law, it is non dilutive. Now what that means is the any type of environmental liability that comes. It doesn't matter who the owner of that property is now. As soon as something happens, say you build an apartment building on a super fund site or a site that has a lot of environmental hazards. And then all of a sudden, five years later, someone in that apartment building gets cancer because of the chemicals that are present in the environment. Not only is the current owner of that facility liable, but everyone in the chain of title is also liable.

So the person that sold it to the current owner, the person that sold it to the person that sold it to the current owner. All of these people are liable for the judgment. So environmental liability is something you really don't want to play around with. So we're always going to request the seller, give us any environmental reports that they've received during their tenures owner. We're going to request time and a due diligence contingency to do a phase one environmental. And if anything comes back, hot, as I call it. If any, if the phase one comes back showing hazards, you have two options. One is you can cancel the contract right there and, you know, walk your separate ways. Or you can get to go to the next step up, which is a phase two environmental report.

Now with the phase two, what they usually do is they'll come to the site and they'll take physical samples. They'll start drilling 20 foot or 60 foot soil samples from the ground. They'll take air readings, they'll take water readings. And if any of those nasty environmental chemicals show up positive, then again, you have choice to make. So just as far as pricing goes, usually a phase one environmental, depending on the size of the facility will be 2,500 to maybe 5,000. Now, if you go to the phase two, now you're looking at anywhere between $5,000 to $20,000 for that phase two, depending on the size of the site and how many samples they need to take and what type of special equipment they need to test those samples. Say the phase two comes back hot. Now you really have a big decision to make. You can either go your separate ways, which is usually what we do. Usually what happens is if the phase one comes back, we'll request that the seller pay for the phase two, or maybe we'll split the phase two with the seller.

The phase two, comes back hot. This is when you're going to need remediation. And remediation can be very drastic. It may require, you know, excavate in the top 16 to 20 feet of top soil. And not only removing that tops out, but going and storing that top soil in a special waste area, a hazardous material waste containment area. Where you have to pay rent on that hazardous material. The cost to do these things are astronomic. It can be anywhere between, you know, 200,000 to a couple million, to a couple hundred million dollars, depending on the scale and the size of the site.

At that point to do a phase three remediation, it just usually doesn't make sense. So we will always walk away from the facility. Usually the only people that are going to be doing phase three and above and hazardous material remediation are going to be these super large developers that are buying, you know, a super fund site, which is a site that the government has designated as an environmentally contaminated site.

When you buy the sites, they're usually some type of incentive for these investors to clean up the area, build something, add some economic, you know, some economic engine to that area. But usually the costs are so astronomical that it is very, very rarely pencils out without the help of multiple government programs stacked on top of each other. So that's another piece in the contract negotiation that we always will push for.

Zoning. For us, we will not buy a property that is not properly zoned. If it is not properly zoned, but we want to change the zoning. We will request that the seller change the zoning or allow us a very long continuancy to work with them, municipalities, to change that zoning for self storage. Before we close on the property, the reason we want to do that is these zoning meetings. You know, the zoning approvals may take six to 12 to 18 months. Sometimes they're not successful. So you just spent a bunch of time and money trying get the zoning approvals changed. So usually what we will do is request that the seller change those for us, or give us, you know, a 12 month or a six month contingency to do those zoning changes ourselves. If we feel confident that the city is receptive to our plans.

One of the things that we always request in our purchase agreements as well is a transfer of all of the IP, all of the technical systems. So for example, if I'm buying an existing self storage facility and let's just call it one, two, three self storage. And it has onetwothreeselfstorage.com, and it has, you know, 1-800, you know, 123-self as the phone number. These are all things that we're going to want transferred to our ownership when we buy the property, because that has intrinsic value for the business. That is part of the goodwill of the business. They can pull that have memorized this number memorized as website SEO and PPC traffic going to these websites. The thing that we want to acquire with the facility as well, instead of starting from scratch.

When it comes to the actual negotiations of the price, this is one of the things that I get very excited about. And I've read a ton of books on this, a few that I really recommend. The first being Never Split The Difference by Chris Voss. It's a wonderful book written by the lead FBI hostage negotiator. He turned a business later on in his career and he uses what's called Tactical Empathy. Making sure that you're really listening to what the seller wants, as opposed to just waiting to formulate a response, but really intaking what the seller is looking for and uncovering the true motivations of what the seller wants.

The seller might say, Hey, I want a million bucks for this facility, but maybe what they really want is they want to be able to put both of their kids through college or both of their grandchildren through college. They want to travel for 12 months and they want an RV camper to travel around the United States. Well, those things have a monetary value and we may be able to accomplish those things for the seller. Not necessarily with a million bucks but maybe we pay them a lower price and carry some financing on the backhand. And maybe we have them seller finance the whole thing. And the down payment is just enough to start some of these, maybe, you know, each year say it's a.

This is a type of deal that we've done in the past. There was, this is on a single family home, but there was a seller that wanted to put his kids through college. And the tuition at a college is $14,000 a year. So this seller was asking for the full tuition upfront, but one of the things that we start to say, Hey, why don't we pay you 14,000 a year as installments that way we still accomplish that goal that you're looking for, but it doesn't make us outflow all this cash. You know, there's this simple concept of net present value, which is cash today is worth more than cash tomorrow. So if I'm going to have to shell out a bunch of cash today, as opposed to showing out the same amount of cash over time, it's actually more advantageous for me to show up at the same cash over time.

Another book I really recommend when it comes to negotiations and sales psychology is Pitch Anything by Oren Klaff. It's a book that teaches you how to speak to the risk centers of the brain. Everyone thinks that when I speak to you, you're processing it with your prefrontal cortex. The highest level of the brain. But that's really not how it works. What usually happened to the first goes through the, what they call the reptilian brain or the oldest part of the human brain. And that part of the brain just, is just a cognitive miser. It is, using brain powers so expensive on the human body, as far as energy usage, that it's better to first look at something and say, do I need to spend more time analyzing this? Or can I, you know, fight or flight it? Can I run? Is it going to, is it dangerous to me? Whatever it is. And dangerous, it doesn't have to be like physical danger, but it can be, you know, something doesn't feel right or whatever it is that usually that gut reaction you feel that is from you.

Your, the oldest part of the brain, really trying to divide information and saying, Hey, does this warrant further analysis or does this, does this, you know, should we just get, get away from this as soon as possible? Then it goes up to the next level, which is kind of the emotional center of the brain. You know, how does this make me feel? How does, how does this interact with my social interact with other people? And then finally I have to mix through that process. Then it goes up to the prefrontal cortex. We started making numbers and math. And does this number make sense as the interest makes sense? So those are two really good books that we recommend all the time for investors when it comes to negotiating contracts.

So let's take a step back. We've gotten all our due diligence materials. We've ran through all the numbers and we've found a number that makes sense or a creative financing structure that makes sense with the seller. At this point, we put it on paper. And now we need to start verifying everything. This is going to be, you know, we're going to do market studies. We're going to do competitor analysis to see if all the competitors are full or not full. We're going to see if there's a value add potential to this facility. Maybe I'm buying below my threshold. My typical annual returns that I'll buy at my cap rates. But this say this facility has the ability to be doubled in size and to double the income, you know, over a relatively short period of time, maybe 18 months, then it may make sense to buy it at a lower return because the future value, we can push that value farther up.

Now, sometimes it doesn't go according to plan. Sometimes through your due diligence period, you find things that you were not familiar with, or that were misrepresented, and then you're going to have to renegotiate. And one of the biggest things I tell people when it comes to negotiating contracts is, you truly have to be prepared to walk away from the deal. Whoever is willing to walk away from the deal has the upper hand in the negotiation situation.

So here's a perfect example. I was buying a self storage facility in the mountains of Tennessee. And when we were speaking with a seller, all the numbers really looked good. Everything looked great. When we asked him about the condition of the property said, Oh, everything's basically brand new, go check it out. Well, it turns out about 45 days into our due diligence period. We took a plane out there and when we walked the facility, we were in awe. When he said everything was new, what he meant was he just painted over any defects in the facility, pretty terribly. But what we found is that all 118 doors are rotted out. So we're going to have to change out all those doors. We're going to have to repair the roofs. We're going to have to level the gravel, the electrical system for the gate wasn't working properly. There was a ton of water damage throughout some of the units had water leaking into them.

That was tough. We were on 825 or 850 on the purchase agreement. And I had to call the seller and say, Hey, you know, Mr. Seller, this doesn't, this is not what we agreed to. You said everything was new. When we got to the facility, the manager told us you haven't seen the facility in five years. You haven't been there in five years. You lived in a different state. And that she had requested multiple times to fix a lot of the deferred maintenance, which you refuse to do. So because of that, you know, we're going to have to drop the price about $150,000.

And he was, you know, that's not what we agreed upon. We had a contract at this price and I just told him, I said, Mr. Seller, you know, we had a contract based upon the information you gave me. And you told me "Everything is basically new" I'm seeing that we're having a ton of work here. That's going to have to be done. You can either walk away now, or you can lower your price. Well, he was having a hard time lowering his price. So what we ended up doing was hiring a third party to do these assessments for us. So we hired an engineering company. Usually it's a civil engineer, they'll perform this work and they will do, what's called a Property Condition Assessment or a PCA.

Usually you can order the PCA and the phase one environmental at the same time and get a better price. So the civil engineer went out to the site. He went through everything, he took a hundred something photos. He did an in depth analysis and he actually created a chart that said over the next 10 years on a yearly basis, here's how much in repairs and deferred maintenance that you will have to fix every year for the next 10 years. And that added up to about $150,000. Well, at that point, I sent that report. The PCA over to the side said, listen, this is not me Fernando saying, I need $150,000. This is a third party, civil engineer that put his license on the line to say that this facility needs 150,000 in deferred maintenance because you neglected it. So there's two ways the seller can make money, right? They can make their money now, or they can make their money later. What the seller chose to do was to make his money now, and as opposed to putting money in and doing the preventative maintenance that would have cost so much less than 150,000, he decided to not put a single diamond to the property, pull all of the money out as possible, just bleed it dry.

But then when it came to go sell, he couldn't sell it for the price that he wanted because all of that deferred maintenance was going to have to be recaptured in that purchase. So in the end, we got the property reduced down to 725,000. I was able to cut a couple of deals with some of the contractors to get the price down to where we needed. And we were able to get a really successful deal there. Ended up buying that facility at, I believe somewhere between a 9% and a 10% cap rate today. And then we added a bunch of self storage, climate control, increase the management systems. We increase the occupancy, we did all the evictions that were needed. So that was a really good deal.

So that's what I'd say is as far as negotiating contracts, you have to be very careful, not only with the contract terms that you're asking for, because in the end of the day, it's not what you said to each other. In a court of law, the only thing that matters is what was written down on the purchase agreement. So you have to be very careful with the types of terms that you're requesting.

And then the second component of that is making sure that you're getting the price to where it needs to be, and that it's accurate and telling the seller upfront, listen, you know, here's how we buy based off of these criteria. And if everything you're telling me is factual, then this price will stay the same. But if there's any misrepresentations in here, we're going to have to drop a price. And we tell that to them upfront, and it usually helps a lot. And it almost puts the ownness of being truthful on them. From the beginning, before we even start the relationship to go down the road of buying the self storage facility. My name is Fernando Angelucci. And I'm The Storage Stud.