We like to talk about good deals, but the truth is, bad deals are inevitable. When you find yourself in a bad deal, what should you do? I sat down with Joe Massey, a lender with Castle & Cooke Mortgage, to discuss how to get through it and move on to the next deal. We looked at three scenarios of real deals that turned bad and what he learned from them.
- Listen to the podcast “#319: What to Do When Real Estate Deals Go Wrong” on the Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Scenario 1: What do I do if I realize I have a bad deal when I’m still under contract?
In 2015, Joe was under contract for a property that had a great price and a cap rate of 7.5-8. On paper, it looked like he hit a home run. He wrote up his standard contract—inspection with no objections and an appraisal gap. He expected to make some minor upgrades, such as new paint, carpet, and refreshing the bathrooms, around $5K in all. During the inspection, however, he found out the property was in worse condition than it appeared and would need about $25-30K in renovations to fix all of the roof, sewer, and plumbing issues.
Even though he was getting the property at a discount, he would need to spend so much money on renovations that the cap rate would start dropping. Joe usually looks for turnkey properties because he doesn’t like dealing with the unknowns of renovations and knows that his strengths lie on the financial side, not rehab. He talked to his agent, who showed him that he could still make money on the property, and Joe felt torn. He wondered if he should go ahead with the renovations until he remembered the strategy he’d written out earlier when he wasn’t emotional.
He has a clear buy box and knows what his strengths and weaknesses are. This property didn’t fit that strategy which meant he couldn’t go through with buying it. Even though he lost $350 from the inspection and $1K from earnest money going hard, he saved himself much more by canceling the contract. $1K is a substantial amount of money, but it’s a lot less than $25K.
While this was a bad deal for Joe, it doesn’t mean it was an objectively bad deal. Someone who wanted a property to renovate could have done well here. But that isn’t what Joe’s strategy is, and it doesn’t align with his strengths. Bad deals are not always just bad deals; it’s about how they relate to you as an investor.
Scenario 2: How do I pivot after I’ve closed on a property?
Sometimes you don’t realize you’re in a bad deal until after you’ve closed on a property. In this case, Joe had a client who bought a property for a great price in a complex that they’ve worked with many times before. After closing, the client started to renovate the property and realized that the area wasn’t as desirable as he thought. There was a lot of nearby gang activity, crime, and his car was vandalized. As a landlord, he didn’t feel comfortable putting a tenant in the unit.
The client called Joe and agent Preston Newberry and told them how he was feeling. Both of them suggested they figure out the new value of the property and sell it. Luckily, we’re in an appreciating market and the client was able to recoup his initial investment and make a small profit of $8-10K.
Even though real estate is all about holding onto property, sometimes it isn’t worth the mental and emotional toll that would entail. It’s important not to sweat the details and look at it from the long-term perspective: saving yourself years’ worth of stress is worth a small monetary loss. Walking away from a property may not be ideal, but sometimes it’s the right move.
If you get into a bad deal, don’t be embarrassed. Call your agent, lender, and advisors, and let them know how you feel, and ask them to take a look at it. Get an outside opinion, especially from people like Joe who look at numerous transactions every day. We encourage our audience to reach out to us with questions because part of our business is helping people figure their options and giving advice.
In this case, the client didn’t overextend himself and tie up all of his capital into this property. He had reserves that enabled him to sell the property and walk away without losing anything.
Scenario 3: What options do I have when my property isn’t performing as expected?
In December 2019, Joe and some partners bought a commercial office building in Colorado Springs. At the time, the vacancy rate was about 25%, so they planned on doing some minor renovations to try to get occupancy up to 90-95%. Covid hit in March of 2020, and instead of getting new tenants, they started losing the ones they had, and the vacancy rate increased to 40%.
The good news is that the rent they’re getting from the remaining tenants is servicing the debt, so they aren’t having to put in additional money to stay afloat. Now that they’re two years in, it’s time to sit down and figure out the strategy moving forward.
They’ve come up with three options:
- sell the building at a loss
- keep trying to get tenants
- convert the property into residential units
If they sold the property, it would probably be at a 10-15% loss, and they wouldn’t get all of their down payment back. Continuing to look for new tenants hasn’t been working, and they’ve discovered that the specific area where the building sits is particularly bad for commercial buildings due to a variety of factors they can’t control.
Converting the building into residential units will take time and capital, but the building is already zoned for residential use, and the housing shortage makes it likely they’ll find tenants. They’re leaning toward this option because they have adequate funds to do it, and they’ll get approved for a loan because none of them overextended themselves when buying this property.
By getting a good price in the first place, underwriting it appropriately, and not overextending themselves, they now have options for how to move forward. Not overleveraging themselves means they don’t have to settle for the worst option.
How can good partnerships help you with bad deals?
Having a good partnership can help you get through a bad deal. Joe has several criteria for what makes a good partner. The first is trust—he has to implicitly trust the people he’s working with to make good decisions. Next is being financially solvent; if they have to pivot, does the partner have additional cash to invest? If they can’t, then he’s on the hook by himself. Finally, they need to bring value to the relationship. Joe’s partners are smart business people, and he trusts that they can be open and honest about their expertise. He’s learned the importance of being able to tell his partners what he does and doesn’t know, and that’s strengthened their relationship.
There are three main takeaways for people to know for overcoming a bad deal:
- Don’t be afraid to lose a small amount of money in order to prevent losing a large amount of money
- Don’t be afraid of canceling a transaction whether it’s before closing or selling it after buying it
- Don’t overleverage or overextend yourself
Being in a bad deal is a matter of when not if. But, keeping these pieces of advice in mind will help you navigate through it.
You can use these 3 buying investment property in Colorado – spreadsheets to help you evaluate the performance of your rental property.
Connect with Joe
If you’re in a bad deal and want some advice or are interested in lending, you can contact Joe here:
- Direct line: 303-809-7769
- He’s also available on Facebook and LinkedIn
Write a Chapter for the 2022 Guide
While Joe primarily writes down his strategy for himself, for the past three years he’s also been sharing it publicly in our yearly investing guide. Having his strategy written out in advance helps him tremendously when things don’t go according to plan.
He physically jots down his goals because if it’s not written out, then it’s a dream and not a real goal. Sharing his goals with people helps him figure out how to achieve them and gives other people the chance to learn from them, too.
To share your strategy and goals for 2022, reach out to us to write your very own chapter in next year’s book. Even if you’re a brand-new investor who thinks you don’t have anything to contribute, make some goals and share them so that other new investors can learn from them, too.