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Part 2: Negotiating changes the question

In a previous post, I noted that people in the real estate industry benefit by being skilled negotiators. Mostly, that post focused on tactics which are privately profitable and which apply to other situations, such as buying a new car or starting a new job. Effective negotiating in a real estate context may be special because it is less about asserting an answer and more about asking the right question. Negotiations tell you something about the situation that usually cannot be reduced to a formula.

For example, consider phrases such as “market value” or “market price”. Real estate markets display a number of features which are more complicated than the way these phrases are studied in an ordinary undergraduate business classes. Real estate markets are “illiquid”; transactions are infrequent and costly.

Consequently, there is a difference between what a buyer is willing to pay and what a seller is willing to accept. This fact confuses some people who try to apply a valuation formula (such as net present value) and treat it as the magic key to find the right answer. This fact means that finance experts sometimes get confused when applying usually-reliable formulas to questions in real estate finance. (Real estate markets are not as informationally efficient as those for widely traded stocks.)

Having a formula seems to reduce a negotiation problem to an algorithm, but reaching a lasting agreement with somebody else requires something more.  It takes more knowledge and more guts to recognize when a deal is good and when to walk away from a bad deal.

Walking away usually means waiting for somebody else.  But, how long? Bargaining room, measured in the many $10,000s for a residential property, adds uncertainty when analysing trends in the “market price” (in addition to the usual problem of real estate being heterogeneous).

Focusing on “comparable properties” provides some help but is less useful to somebody who has a great idea to redevelop the property to a different “highest and best use”. Analysts need to bring insight rather than rely on common formulas.

Negotiating effectively is not just about tactics or reacting to the tactics used by the other side. The fact that negotiations are common in real estate markets also affects the information used to determine bargaining positions and bargaining power.

So, negotiations make life interesting in many ways.  And that is why so many people are drawn to real estate as a business.