Finance and Insurance - The Profit Center
I would like to make myself clear on a few items of interest before I get too deep into the sales processes at any dealership, including: automobile, recreational vehicles, boats, motorcycle, and even furniture or other big ticket items. A business has to turn a fair profit in order to stay in business. I believe that they should make this profit and use it to pay better quality employees a premium wage in order to serve you better. The financial strengths or weaknesses of any business can definitely have a dramatic effect on your customer service and satisfaction. I do not, in any shape or form, wish to hurt a dealerships profitability, as it is essential for his survival. I merely want to advise people how to negotiate a little better in order to make the profit center more balanced.
Let's get right down to this! Every dealership has a finance and insurance department. This department is a huge profit center in any dealership. In some cases, it earns more money than the sale of the automobile itself. Profits are made from many things that most buyers do not understand.
You as a consumer should understand the "flow" of the sales process to understand the profit centers that are ahead of you. Most negotiating from the consumer seems to stop after the original price is negotiated and agreed upon. Let's examine just a small portion of what leads up to that point.
The first thing that every consumer should understand is that when you go to a dealership several things come into play. One of the most important things that I could point out to you is that you are dealing with a business that has been trained to get the most amount of money from you as they can. They are trained and they practice these tactics everyday, day after day, week after week, month after month, and year after year. Let me point out a couple of important facts that I have said in this paragraph. First, you'll notice that I said a dealership and not a salesman and secondly, I emphasized times of day after day, week after week, etc. etc. This was done to let you know that the salesman is working very closely with the sales managers in order to make as much money as he can. Your interests are really not their objective in most cases.
One tactic that is used heavily in the business is that the salesman says he is new to the business. This may be true or not, however; keep in mind that he does not work alone. He is working with store management, who gives him advice on what to say and when to say it. These guys or gals are very well trained on how to overcome every objection that you may have to buying from them. They have been trained in the psychology of the buyer and how to tell what your "hot buttons" are. They listen to things in your conversation that you may say to one another as well as to the salesman. They are trained to tell their desk managers everything that you say and then the desk manager is trained to tell the salesman exactly what and how to answer you. A seasoned salesman does not need as much advice from his desk and may negotiate a little more with you directly without going back and forth.
The process of negotiation begins the moment that you walk into the front door or step foot out of your car and begin to look at vehicles. Different stores display inventory in different ways. This is done for crowd control or more commonly known as "up control". Control is the first step in negotiating with a customer. Ever who asks the questions controls the situation. Let me give you an example: A salesman walks up to you and says "Welcome to ABC motors, my name is Joe, and what is yours?" The salesman has just asked the first question- you answer "My name is George." He then asks you what you are looking for today, or; the famous "Can I help You?" As you can see, step after step, question after question, he leads you down a path that he is trained to do.
Many times a well trained salesperson will not answer your questions directly. In some cases, they only respond to questions with other questions in order to avert the loss of control. An example of this could be something like you asking the salesman if he has this same car with an automatic rather than a stick shift. Two responses could come back to you. One would be yes or no, the other could very well be something along the lines of: 'don't you know how to drive a stick shift?" In the second response the salesman gained more information from you in order to close you. Closing means to overcome every objection and give your customer no way out other than where do I sign. The art of selling truly is a science of well scripted roll playing and rehearsal.
We have established that the negotiating process begins with a series of questions. These questions serve as two main elements of the sales process. First and foremost is to establish rapport and control. The more information that you are willing to share with you salesman in the first few minutes gives him a greater control of the sales process. He has gathered mental notes on our ability to purchase such as whether you have a trade in or not, if you have a down payment, how much can you afford, are you the only decision maker (is there a spouse?), how is your credit, or do you have a payoff on your trade in? These are one of many pieces of information that they collect immediately. Secondly, this information is used to begin a conversation with store management about who the salesman is with, what are they looking for, and what is their ability to purchase. Generally, a sales manager then directs the sales process from his seat in the "tower". A seat that generally overlooks the sales floor or the sales lot. He is kind of like a conductor of an orchestra, seeing all, and hearing all.
I cannot describe the entire sales process with you as this varies from dealer to dealer, however; the basic principals of the sale do not vary too much. Most dealerships get started after a demo or test drive. Usually a salesman gets a sheet of paper out that is called a four square. The four square is normally used to find the customer's "hot points". The four corners of the sheet have the following items addressed, not necessarily in this order. Number one is sales price, number two is trade value, number three is down payment, and number four is monthly payments. The idea here is to reduce three out of the four items and focus on YOUR hot button. Every person settles in on something different. The idea for the salesman is to get you to focus and commit to one or two of the hot buttons without even addressing the other two or three items. When you do settle in on one of the items on the four square, the process of closing you becomes much easier.
One thing to keep in mind is that all four items are usually negotiable and are usually submitted to you the first time in a manner as to maximize the profit that the dealer earns on the deal. Usually the MSRP is listed unless there is a sales price that is advertised (in may cases the vehicle is advertised, but; you are not aware). The trade value is usually first submitted to you as wholesale value. Most dealers request 25-33% down payment. Most monthly payments are inflated using maximum rate. What this all boils down to is that the price is usually always negotiable, the trade in is definitely negotiable, the down payment may be what you choose, and the monthly payment and interest rates are most certainly negotiable. If you do your homework prior to a dealership visit you can go into the negotiation process better armed. You still need to keep two things in mind through this process. The first item is that you are dealing with a sales TEAM that is usually highly skilled and money motivated. The more you pay the more they earn. The second item to remember is that you may have done your homework and think that you are getting a great deal and the dealer is still making a lot of money. The latter part of this statement goes back to the fact that it is essential for a dealer to make a "fair" profit in order to serve you better.
Once your negotiations are somewhat settled, you are then taken to the business or finance department to finalize your paperwork. Keep in mind that this too is another negotiating process. In fact, the finance manager is usually one of the top trained sales associates that definitely knows all the ins and outs of maximizing the dealerships profit. It is in the finance department that many dealers actually earn more than they earned by selling the car, boat, RV, or other large ticket item to you. We will break these profit centers down for you and enlighten you as to how the process usually works. Remember that finance people are more often than not a superior skilled negotiator that is still representing the dealership. It may seem that he or she has your best interests at heart, but; they are still profit centered.
The real problem with finance departments are that the average consumer has just put his or her guard down. They have just negotiated hard for what is assumed to be a good deal. They have taken this deal at full faced value and assume that all negotiations are done. The average consumer doesn't even have an understanding of finances or how the finance department functions. The average consumer nearly "lays down" for anything that the finance manager says. The interest rate is one of the largest profit centers in the finance department. For example, the dealership buys the interest rate from the bank the same way that he buys the car from the manufacturer. He may only have to pay 6% to the bank for a $25,000 loan. He can then charge you 8% for that same $25,000. The dealer is paid on the difference. If this is a five year loan that amount could very well be $2,000. So the dealer makes an additional $2,000 profit on the sale when the bank funds the loan. This is called a rate spread or "reserves". In mortgages, this is disclosed at time of closing on the HUD-1 statement as Yield Spread Premium. This may also be disclosed on the Good Faith Estimate or GFE. You can see why it becomes important to understand bank rates and financing.
Many finance managers use a menu to sell aftermarket products to you. This process is very similar to the four square process that I discussed in the beginning. There are usually items like gap insurance, extended service contracts, paint and fabric guard, as well as many other after market products available from this dealer. The menu again is usually stacked up to be presented to the consumer in a way that the dealer maximizes his profitability if you take the best plan available. The presentation is usually given in a manner in which the dealer wins no matter what options are chosen. With the additional items being pitched to you at closing, your mind becomes less entrenched on the rates and terms and your focus then turns to the after market products. Each aftermarket item can very well make the dealer up to 300-400% over what he pays for these items. Gap coverage for example may cost the dealer $195.00 and is sold to the consumer for $895.00. The $700.00 is pure profit to the dealer and is very rarely negotiated down during this process. The service contract may only cost a dealer $650.00 and is being sold for $2000.00. The difference in these items are pure profit to the dealer. You see, if you only paid $995.00 for the same contract, the dealer still earns $345.00 profit from you and you still have the same coverage that you would have had if you had paid the $2000.00. The same is true for the gap coverage. You are covered the same if you paid $395.00 or $895.00 if the dealers costs are only $195.00. The only difference is the amount of profit that you paid to the dealer. Another huge profit center is paint and fabric protector. In most cases the costs to apply the product are minimal (around $125.00 on average). In many cases the dealer charges you $1200-$1800 for this paint and fabric guard.
As you can see, these products sold in the finance department are huge profit centers and are negotiable. I also have to recommend the value of most all products sold in a finance department. It is in your best interest to get the best coverage possible at the best price possible. Always remember this: The dealer has to make a fair profit to stay in business. It just doesn't have to be all out of your pocket.
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Financing Apartment Buildings
First it was the boom, then it came the bust, and now it's the bear market. Despite the massive liquidity injected by the Fed, overall the U.S. real estate has yet to experience more bearish seasons. But there is one branch of the real estate sector that appears to be exempt from the deflationary pressures of our economy. Apartment buildings are gaining popularity due to exceptional levels of high occupancy. Therefore many investors have made the decision to park their money in this kind of investment. If you're new to multifamily investing you will most likely want to know as much as possible about the world of financing. While each transaction is unique and underwritten on a its own merits it's worth knowing that there are a few basic requirements commercial lenders use. If you're a seasoned investor you could still benefit from keeping up to date on such criteria especially if you're looking at acquiring a new property or refinancing one that you already own. The Collateral The underlying asset is among the first on the lender's list to review. This is the security the lender uses for taking the risk of lending you money. Therefore, the building you own or looking to buy represents the source of repayment for the commercial loan. Believe it or not with very few exceptions lenders do not like distressed properties and REOs. These kind come with a myriad of problems such as high vacancies, management and tenants issues, title, lack of maintenance and or upgrades, local economy, and in many cases inability to service debt. As a result, hard money may be one of the very limited financing options. For conventional transactions great emphasis is placed on the property and its condition. In case of foreclosure, the lender wants to be sure it has a marketable property. This is the reason for which the lender will typically not allow the borrower to choose the appraiser. The commercial appraisal is detailed and it utilizes three variables to derive the property value: income approach, replacement cost, and sales comparison method. The income approach carries the utmost important factor in determining the collateral approval. A building could be fancy, well-maintained, and in a great location, but if the income is not there to support the value the collateral does not pass the test. The Cap Rate Among other factors worth mentioning are the age and condition of the property, the vacancy rate, and the area market capitalization rate. The "Cap Rate" is a ratio used to determine a property's value based on its generated income. It's computed by taking the rental net operating income (NOI) and dividing it by the property's fair market value (FMV) or sales price. The lender will then compare the property's Cap Rate with the general area's rate for similar properties. The red flag arises when the ratio is lower than the norm, therefore a higher cap rate is certainly desirable. Conversely, a very high ratio raises another red flag. Rest assured that an underwriter would question why a property has such a high ratio. Are there any underlying issues that could potentially affect the property in the future? Remember that an underwriter has a detective's eye, he/she is looking for what could go wrong before looking at the positives. If you're looking at buying an apartment building something tells me you'd want to first look at the Cap Rate. Often a high ratio means a better deal for you. If the area's Cap Rate is approximately 8% and the property you're looking to buy has a 5% ratio you must justify why you're buying it. What is it that compels you to pay the higher price? Remember also that the appraisal will put a heavy emphasis on the lower ratio. Now, let's do some quick calculations as an example. We'll assume that you're trying to determine between two previewed properties. The first property has a NOI of $35,000 and an asking price of $600,000. The second property has a NOI of $15,000 and an asking price of $150,000. Which one would the Cap Rate suggest is a better investment? Obviously, the second property since the Cap Rate is 10% ($15,000 / $150,000) versus 5.8% ($35,000 / $600,000). On the other hand, if you're the proud owner of an apartment complex and you want to figure out its estimated value, you can do this by first learning what the area Cap Rate is for your location. Let's say the area Cap Rate is 8% and your property's NOI is $42,000. You can then easily determine your value at $525,000 ($42,000 /.008). The Cash Flow Cash flow plays a significant role when underwriting a multifamily loan. Within the industry the cash-flow analysis is known as the Debt Coverage Ratio ( DCR). Such ratio measures the property's net income ability to cover the annual debt service. The lender will analyze the property's rent-roll - and the financials - and determine the annual income and expenses. After that it determines if the annual cash flow can service the new debt. The DCR is calculated by dividing the property's annual NOI by the property's projected annual debt service (based on the new loan). Annual debt service includes the principal and interest payment only. Taxes, insurance, and the rest of the expenses have already been deducted when determining the NOI. Lenders are looking to see a minimum of 1.25 ratio, meaning that for every $1 of debt service the property must generate a minimum of $1.25 in net operating income. So, let's say a building's NOI is $35,000 while the annual P&I is $27,000 (or $2,250 monthly). The resulting DCR is 1.29, a ratio within the guidelines. However, a mere increase of a half percent on the rate could bring down the ratio below 1.25 thus putting the loan in jeopardy of being denied. Borrower Strength Most loans funding today are recourse loans. It means that lenders are not satisfied with the collateral only and you, as the borrower must provide a personal guarantee; which implies that your credit and financial strength will be scrutinized. Keep in mind that even if title to the property is vested in the name of a corporation, LLC, or some other form, lenders still require personal guarantees from their owners or members. Underwriting trend is rather conservative so lenders expect you to prove a great credit history, sufficient apartment building experience, and a decent net worth with a generous amount of liquid funds. When it comes to the capital invested or equity owned most programs want to see the borrower's equity at twenty percent or more. Your net worth should look impressive. Fannie Mae, for instance, wants to see the borrower's net worth be at least the loan amount requested. Finally, the apartment building is the primary source of collateral and loan repayment, therefore it carries more weight when compared with the borrower during the loan underwriting process. Still, the strength or weakness of the borrower will ultimately impact the approval or denial of the loan. A loan package meeting these basic requirements creates the foundation for a successful loan approval. However, keep in mind it doesn't necessarily mean that a transaction that meets the criteria is automatically approved for a loan. Still, not meeting any one of the above requirements will most likely end in denial of your commercial loan request. The Lending industry is quite chaotic and unpredictable, especially in today's economic environment. Banks will like your deal today and hate it tomorrow. Most commercial loans are originated today as Portfolio Loans. This means the lender keeps the loan in their portfolio for the entire term. So, if they find today they have too many retail centers in their portfolio, they will decide - over night and without a warning - to shift to apartment buildings.