When I was a kid, trying new things and making mistakes were all a part of the process. At that time, everything was new, so if I wanted to do ANYTHING, I had to try new things. And although mistakes and failure were inevitable, I wasn’t necessarily afraid of the repercussions.
Why not? All of the mistakes I made had consequences and all the consequences hurt. They all stung, and they all acted as some sort of deterrent on my way towards a goal. But they were also an integral part of the learning process.
Yet there comes a point in most of our lives where we seek to avoid pain and failure altogether. We seek the comfort of routine, the security of a fixed income, the safety of our soft and cozy couches. We stop taking chances, we stop taking risks.
Why?
Because we become conditioned to believe that making mistakes should be avoided at all costs! Even at the cost of one’s dreams and aspirations…
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In May 2021, my team and I lost 60k on one deal.
Talk about sting…
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So what happened? (Let’s get this over with…)
We found a 20 unit deal in a great neighborhood in Tampa. The price was right and rents were at least $200 under the market. It didn’t have many eyes on it because it was an off-market deal that we found through a wholesaler – score!
We jumped on the opportunity. Got super excited and planned for an absurdly quick, 3-week close!
And we went hard with $50k.
We were excited and confident in the deal and our business plan. We couldn’t stop talking about it. But after a brief call with one of our mentors regarding how to structure our partnership, he pointed out a flaw – Our financing was too risky. How the hell did we miss this??
Lessons:
- When negotiating, make sure you are comfortable with the offer price. I was too eager to get this deal under contract and would have actually been more comfortable at a lower price point although there was still plenty of upside. I’d been searching in Tampa for 18 months and got too eager to land a deal.
- Also, When underwriting, be conservative. Yes, we beat the term “conservative” to death in this industry, but for good reason. Make sure you leave plenty of room for errors in all aspects of your underwriting. Then double/triple check your work. And remember, there are always other deals.
- When drawing up the contract, make sure you have given yourself an adequate DD (due diligence) period because there are always issues and setbacks. Also, Make sure you give your lender adequate time to close AND keep on their case constantly. If the seller is unwilling to accommodate these requests – highly consider walking.
- And don’t go hard with your EMD (earnest money deposit) unless:
- This is the deal of a lifetime.
- You are certain you will close.
- You can afford to lose it.
- And there is absolutely no other way to win the deal.
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Get the right debt
We had planned on securing bridge debt to help us close within the 3-week time frame. Our only viable options were either bridge or hard money given the time constraints.
Terms of the loan –
- 8% IO for 2 years
- 85% LTC
- 100% construction costs
We also had the option to defer the first 12 months of interest-only payments. Taking advantage of this would have made year 1 cash-on-cash look phenomenal. On top of that, we felt we had a solid business plan based on professional guidance from a variety of trusted property managers and deep knowledge of the market. ALSO, one of our partners had a solid case study with a nearby property he successfully repositioned with a similar business plan.
More lessons: There were a few issues that we always consider but for some crazy reason, we overlooked on this deal –
- Year 1 would be cash flow negative due to the high-interest rate of the bridge loan. When we underwrote the deal, we had to push at least the first 6 months of IO payments off until the refi to be cash-flow positive. This put pressure on the refi.
- Now suppose cap rates in the local market decompressed a bit… We had underwritten for a 20 bps increase in cap rate by the end of year 2 which is standard, but there would have been no cash return at refi. Too risky.
- To add to the previous issue, suppose we couldn’t achieve our pro forma rents? We were somewhat aggressive on our rent projections, and although I feel confident it would have been achievable, it certainly wouldn’t have been easy. Any bumps in the road would have put even more pressure on the refi.
- And what if we needed more time to reposition the property than originally planned for? -Supply chain issues, cost of lumber, issues with contractors…The bridge loan we were securing was super expensive. The longer we kept it, the more we’d bleed. On top of that, the loan would come due at the end of 24 months regardless of how well we implemented the business plan. Yikes!
So, yea… The bridge loan was not the right debt instrument for this project.
What next? We began discussions within the team to try and secure a conventional loan from a community bank. At this point, the building was 85% occupied and a couple of local banks were willing to take this deal on and even offered us some very favorable terms. This strategy, however, would require a minimum of 45 more days to close.
We would need to negotiate an extension.
At this point, we were a week into the process and had already completed multiple inspections and visits to the property. The seller was livid. He apparently wanted to keep the sale quiet so that tenants wouldn’t catch the wind and leave. Because of this, and as per the wholesaler; the seller was unwilling to negotiate an extension.
We thought (and hoped) that they may have been bluffing.
Notable point – Our team had the ability to close this deal. No question. We easily covered the net worth and liquidity to fund the deal within the core team and we were strong buyers on paper. We figured that the seller had more to lose by going with another buyer than waiting another 45 days for us to close.
We were wrong.
At this point, some of you may be thinking that we could have gone directly to the seller to negotiate without the wholesaler. But we couldn’t, we would have been in breach of contract had we done so.
More lessons: Don’t give people the benefit of the doubt that they have your best interest in mind. Some people are motivated by profit, not reputation or relationships. It became evident that the wholesaler was banking on us failing to keep our earnest money and sell to another buyer.
To be blunt – The wholesaler was unethical, aggressive, rude, and unprofessional. He yelled and cursed at one of my partners and the property manager during our inspection for “taking too long.” And although I am very turned off by this person, and could continue on… I will leave it at that. I am sure you can imagine the trauma of negotiating with such a person for over a month and what other antics he attempted…
At this point, we had lost quite a bit of confidence in the deal but pushed forward. I mean, what other option did we have? We were about to lose 50k.
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Back to the drawing board
We brainstormed like psychos. To the point where it became unhealthy. But we managed to come up with a ton of viable solutions for most of the issues we were facing. On the debt side, we had contacted multiple lenders, one of which we should have gone with, in hindsight… but unfortunately ended up sticking with the original lender who “assured us” he could close (we were also reassured by his company’s COO).
Another lesson – If you have any doubt that the lender may not be able to close… switch lenders. It was us who had $50k on the line – not them. We had a great alternative lender that we should have gone with.
Here are some more details –
- We were in contract for 2.25m
- The lender completed a desktop appraisal and found our ARV to be 3.6M!?
- Lesson: We should have questioned his underwriting from the beginning. But we didn’t, we trusted him, even though our instincts and market knowledge warned us that this ARV was off…
- Due to the time crunch, a commercial appraisal was out of the question. Interestingly, this property consists of 5 quadplexes…. So we had the option to appraise them as residential properties rather than as a 20-unit commercial building, which would save us time. We pulled comps and felt pretty confident in going this route. We still planned to refinance in 12-18 months using a commercial appraisal because we were confident we could enhance the NOI to get a favorable ARV. We of course confirmed with the county this was possible and felt, at this point, that we had plenty of viable exit strategies even given the risky bridge loan.
But we were nervous, to say the least.
- Appraisals were backed up and we paid to have them rushed, but even then we ran into problems. We ended up getting BPO (broker price opinion) appraisals done just to give us some context before the actual appraisals. These came back highly unfavorable and we took another confidence blow in the deal. What is going on? They valued the units at 83k a door! D-class doesn’t even sell at this price point, and this property is located in a B- neighborhood!
And still, we continued forward.
- We hoped that the actual residential appraisals would come back favorable. And they did, partially.
- Problem 1 – the residential appraisal didn’t come in until the night before closing. Of course.
- Problem 2 – the “as is” value was spot on, the ARV was wayyyy off.
The gripping pain in our stomachs throughout this entire process reached a new pinnacle at this point. I wasn’t eating or sleeping well and I felt that it was all my fault for getting my team in such a position.
This was not worth it, and what I mean by that is, the amount of money we were set to lose wasn’t worth the pain we were creating for ourselves. Could I afford this financial loss? Hell no! I am currently in the worst financial position of my life and am strapped with debt.
Regardless, the pain I was experiencing was self-inflicted. The reality is, advancing our positions in life is an aspiration as well as a choice. I knew the risk and the consequences from the onset. Not everyone pursues their goals in life, and doing so is hard work, involves risk, and can be riddled with all types of “stings”. But we can’t just give up on our dreams. Just as we didn’t give up trying to ride a bike when we got a scrape or a bump; we don’t give up now.
You see, life is just a game until you decide to make it serious. It is your choice, you can interpret any sting or loss as an obstacle that cannot be overcome; as a reason to quit. Or you can accept it as part of the journey.
Your dream isn’t going to fall in your lap. Sorry. It doesn’t work that way.
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Confidence boost… We had the deal fully funded 4 days prior to closing.
Since we were still moving forward, we were seeking JV partners for this deal. One of our team members worked diligently to find the right partners for this situation. Integrity and honesty are key in this business, and we were open and transparent about the risks involved when pitching the opportunity to potential partners.
In the end, when we opened it up for funding, there were nearly half a million dollars in the bank within 3 hours. Although I was no longer very confident in the deal, other people were. (Remember, Tampa is a super hot market, and this deal had some serious potential). Also, we had already covered all of the risk capital, so these new partners really had nothing to lose if we weren’t able to close.
……..
And then, the appraisals came in…
When we received the appraisal reports at 6 pm on a Thursday, and the closing was set for that Friday, we had less than 24 hours to decide what to do. The original terms of the loan had us putting down only 15% and giving us a 300k construction budget. Yet, after the appraisal came in, we were asked to put down 35% and were going to be given NO construction budget.
Could we have made that happen? Possibly… But the deal no longer made sense for us financially. It made more sense to cut our losses here. Aside from the huge downpayment and zero construction budget, we were setting ourselves up for more failure. The property would be losing money from day 1 and we would be banking on a quick refi into agency or community bank debt without a rehab budget! No thank you.
We tried for an extension one last time and were denied.
The wholesaler then pleaded with us to share our inspection report with the “new buyer” claiming he would then “do his best to get our deposit back” and said that “the seller didn’t want to keep our deposit”. All a lie and we knew it. He was under no obligation to return our EMD… but we decided to share the inspection report regardless.
Sometimes it’s best to wipe your hands clean of the mess and walk away.
In the end, we lost our EMD, we lost the deal, and in total, after paying legal fees, inspections, appraisals, etc.; we lost just under $60k.
This stung like mad to say the least… It was a brutal hit that made me question my journey. Made me question whether or not I should continue searching in Tampa, or working on real estate at all. I took a couple of weeks off.
It’s a good thing I am a reflective dude. And after a couple of weeks of reflecting and thinking back to my childhood, I concluded I’d move onward and upward… Thinking back on my childhood and the thousands of stings I’ve felt… all of them unbearable at the time, and all of them now distant memories. I will persevere. I will succeed.
Let this experience be the same. Nothing more than a sting on the journey towards higher aspirations.
Ever forward! One love,
Nico
