Investors are a growing force in the residential real estate market, but how should sellers evaluate these offers?

Joe Kotoch knows what sells houses, and it’s not cracked linoleum, Brady Bunch-era kitchen appliances and stained ceilings.

When Kotoch, 40, makes an overture to a homeowner or, in the case of estate sales, to heirs, he includes an estimate as to how much money and work it will likely take to polish a deflated and scuffed house into buyer-ready condition. Sometimes, sellers look at his plans for updating the structure, systems and finishes, and tell him they could do it themselves and reap the same profit.

“Sure, you can do some of the work, but you’re not going to get the premium you think you’re going to get,” said Kotoch, an investor and realty agent who has been flipping Chicago houses since 2015 and turned six projects in 2021. 

Investors of all sizes wield more power than ever in the single-family home market. They arrive on sellers’ doorsteps armed with truckloads of cash and wielding formulas for extracting return, by renting or reselling. Even seasoned homeowners might be taken aback when investors show interest in their just-listed houses. Investors offer deals that individual buyers can’t, and also a different set of considerations. For most sellers, investors offer a packaged trade-off of efficiency versus top dollar. 

Increasingly, investors are a force in the single-family housing market. National realty brokerage Redfin estimates that in the third quarter of 2021, 18% of all houses were purchased by investors. In Chicago, 8.5% of houses sold to investors during the third quarter of 2021, up from 7% in the year-before period. Nationally, 30.3% of all houses were purchased with cash in 2021, reported ATTOM, a real estate data firm, compared with 22.8% in 2020.

In the past decade, the category of single-family home investment has geared up and now, investors from Wall Street to Main Street can take advantage of new modes of financing, renovating and renting that amplify their returns, say investors and realty brokerages.

Still, the investment machinery depends on a steady stream of homeowners willing to sell to investors rather than the appealing young family hoping to land their first house. Redfin experts note that investors are so hungry for deals that they are reaching into pricier neighborhoods. That means that almost any home seller could find themselves fielding short-deadline offers from investors.

The most important factor for sorting out an investor offer is understanding your own goals for the sale, said Bob Schneider, a certified financial planner with Johnson Financial Group in Milwaukee. “Is your goal to get as much as possible for the house, or is your goal a stress-free transition of the house?” he asked.

Schneider faced a variation of this decision recently himself, when he negotiated with an acquaintance to buy a new house before it went on the open market. Having just sold his first house, Schneider was in position to offer a handsome price and swift close — similar to the terms offered by investors. But, he also had to persuade the seller that the convenience was worth forgoing a potential bonus driven by listing the house and inviting competitive bids.

Part of Schneider’s persuasive pitch was to explain his intentions for the house he hoped to buy; sellers considering an investor’s pitch should do the same, he said. “What are their plans for the house? They don’t have to tell you, but you can do some research to see what they’ve done with other houses they’ve purchased,” he said. “Do they rent or do they resell, and if so, for how much? Do they put any work into their houses?”

And, Schneider and realty agents stress that it’s important to have an agent on your own side who can provide context for any offer from any party, investor or individual.

It’s essential to understand how an investor arrived at the offer price, said Jessica Lautz, vice president of demographics and behavioral insights for the National Association of Realtors.

NAR research indicates that last year, 35% of houses and condos sold for above the list price: 28% captured 101% to 110% more, and 7% pulled in a premium of more than 110% of what the sellers initially asked. “That incremental amount over list is straight into your pocket,” Lautz said. “That becomes your down payment or renovations for your next house.” 

Institutional investors said they use combinations of algorithm-driven valuation models to estimate the likely price a house would fetch on the open market, and make their offers accordingly. But, they also factor in their cost to complete light to moderate updates and a healthy profit margin.

Offerpad, an Arizona company that renovates and resells single-family homes in 15 states, uses a combination of analytics and local agent assessments to arrive at the price it presents to buyers, explained co-founder and CEO Brian Bair. “We know consumers won’t accept a low offer,” he said. Part of the packaged deal, though, is a streamlined process. The sellers won’t have to spiff up their houses, worry about an appraisal that doesn’t support an individual’s high offer or endure the annoyances of complying with a home inspector’s list of flaws that must be addressed.

Kotoch said he approaches likely sellers when he detects properties being sold by heirs, who tend to prioritize expedience over top dollar, and who attach little sentimental value to the houses. He opens the conversation by explaining that he is backed by his own investors — Renovo Financial, a finance company that backs small-scale investors — which means he has cash at the ready.

“It gives me a little more cachet,” he punned. “As I present an offer, I also provide them justification as to why the price is the price. I usually explain that given supply chain and labor issues, that’s why we’re coming at this number. We’ve evaluated this and we can close in two or three weeks.”

And, Kotoch doesn’t apologize for composing his offers with a 20% profit for himself and his partners. Some potential sellers balk — “The biggest disconnect is that sellers are unrealistic about the scope of work and the cost associated with it,” Kotoch said. “They all think you can slap a coat of paint on something and that’s rehabbing. Now, particularly with the supply and labor shortage, it can take three to five months just to get a bid from a contractor. We evaluate it and say, here’s our offer and we can close in two or three weeks.”

As seen on chicagotribune.com