The Fallacy of Off-Market Deals

Author

David Wallace
May 14, 2024 • Estimated Reading Time: 7 minutes

If you are interested in multifamily real estate investing, you have undoubtedly heard investors touting their ability to buy deals off-market.

Every day, I see a sponsor raising money for an investment they sourced off-market. Or I talk to investors who tell me they would never buy a deal listed by a broker.

Every investor seeks to buy properties with significant upside potential. But too many believe great deals can only be found off-market.

Off-market deals offer many benefits for buyers, but narrowing your focus exclusively on off-market deals puts you at a significant disadvantage.

The multifamily investors I know who have built the largest portfolios understand the benefits of both on-market and off-market opportunities. It is a numbers game. If you want more home runs, you need more at-bats.

Today I will be diving into what characterizes an off-market deal. I will discuss the benefits of off-market deal-making and why it is a common topic in our industry.

But I will also talk about why it is difficult to grow a portfolio by only buying deals off-market. I will talk about why so many buyers miss out on opportunities to invest in great deals just because they have a misconceived notion that the only way to buy great deals is to source them off-market.

What Is an Off-Market Deal?

An off-market deal is when a buyer contacts an owner directly and negotiates the sale of a property without competing with other buyers.

If a broker presents a deal to you and says it is off-market, you are likely not the only person seeing it. It’s not off-market.

Why Do Buyers Like Off-Market Deals?

Investors love off-market deals for a few reasons.

  1. Buyers hope to negotiate a discounted price compared to what they would need to pay if it was listed.

Buyers have more control over the negotiation process when they are the only person at the table. They can avoid bidding wars and sidestep restrictive timelines engineered by brokers. They can spend more time studying the property before discussing the price and terms of the sale. They hope to negotiate a sale agreement on their terms and secure a discounted price.

  1. Buyers hope to know more about the market than the owner.

Information asymmetry happens when owners have been out of the buying/selling business for a while. Buyers often hope to exploit the uninformed seller by offering a below-market price.

  1. Buyers hope to negotiate flexible financing terms.

Negotiating with a seller directly can allow buyers to structure deals with creative financing terms such as loan assumptions, seller carrybacks, or contract for deeds.

Why Off-Market Deals Are So Hard to Find

Multifamily investing is a competitive business. It’s a smaller world than you might think.

Let’s look at one of the markets I cover as an example.

There are roughly 4,100 apartment properties with 10 or more units in Hennepin and Ramsey counties. Only 1,700 investors own these multifamily properties.

Dozens of active brokers constantly reach out to owners trying to find properties to sell. If a broker wanted to call every single owner once per quarter, that would be 6,800 calls per year, or 27 calls per business day.

Many brokers make 27 calls per day. Now imagine 50 brokers doing it. On top of that, brokers run regular direct mail and email marketing campaigns to contact prospective clients.

Not to mention there are hundreds of interested buyers out there making cold calls, sending direct mail inquiries, and networking with other industry players looking to find properties to buy.

My point: it is rare for an investor to find an owner who would consider a sale without many other people knowing about it already. It does happen, but very uncommon.

Quick Story

To emphasize my point, let’s look at a recent example.

An investor in Hennepin County had owned a 40-unit building since 2008. For the last 16 years, he had no intention of selling the asset. But over the years he had endured regular inquiries about his property from brokers and off-market buyers alike.

The time came for him to consider a sale, and his approach was simple. He entertained the conversation any time someone called.

He didn’t want to list it, hoping someone would bring him a decent offer to keep the process simple. I brought him an offer. Several of my brokerage colleagues brought him an offer. Within two weeks, it seemed everyone in town knew he wanted to sell.

It wasn’t posted online, it wasn't listed with a broker. By some definitions, this deal would be considered “off-market”. Yet, he ultimately received 9 offers.

When Do Off-Market Deals Happen?

There are two scenarios where off-market sales are more common.

  1. When the buyer and seller already know each other before discussing the sale.

Real estate investors who have amassed sizable holdings are often well-connected. They usually know the other large owners as competitors, collaborators, or partners. When this is the case, it may make more sense for them to trade assets between themselves without all the fuss of bringing a deal to market.

When I see these deals trade, the price is usually very close to market value. Since both parties are professional investors, it is unlikely that the buyer will be able to negotiate a discount.

  1. When the real estate is in a less desirable location

Rural areas, high-crime locations, or places with unfavorable economic conditions attract fewer investors.

In these areas, brokers are less active and the buyer pool is smaller. Owners receive fewer calls from interested buyers and brokers and therefore have fewer options when they decide to sell. Off-market buyers have an opportunity to purchase these assets with less competition.

However, in the future when they decide to sell, they are in the same position- trying to sell a property to a small buyer pool.

Cast a Wider Net

What’s the point?

The multifamily investment market is extremely efficient. True off-market deals are rare.

Limiting your focus to only looking for off-market opportunities significantly reduces your field of vision.

The best way to grow an investment portfolio is to buy more deals - whether you find them off-market or hear about them from a broker. Investors who grow their holdings have systems in place to buy properties more frequently.

Referring back to my baseball analogy, it is more efficient to hit a ton of singles than to step up to the plate occasionally and swing for the fences. Even base hitters will sometimes knock one out of the park.

In real estate terms, buying ten deals with 10% returns makes more money in the long run than buying one great deal returning 20%.

On top of that, buying more properties will help you gain more experience and build rapport with service professionals in your market including brokers, lenders, property managers, lawyers, and title companies.

Your experience will compound over time, putting you in the position to buy more and buy better.

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