The COVID-19 has either postponed or canceled many of the things we take for granted. Basketball and hockey games. Sunday mass. Birthday parties, Friday nights at the brewpub, and all but the most necessary travel.
And then there’s the cessation of so many business activities. From large meat packing plants to the neighborhood boutique, business of all shapes and sizes are shuttered for an indefinite period of time.
Entrepreneurs and real estate investors are feeling the squeeze, too. Today’s guest author, who blogs at Financial Wolves, was planning to become the proud owner of a triplex. Like so many other plans recently made, those plans fell through.
Personally, I think he may have dodged a bullet. He also learned a number of lessons from the deal gone wrong that he shares with us today.
A Real Estate Transaction Gone Wrong – Lessons Learned During A COVID Rental Transaction
Transacting with real estate should be generally straightforward… So I thought.
Unless you deal with an unprecedented pandemic and a nasty seller. Then, things can get messy quickly. That’s okay though because real estate is like a river. If one doesn’t work out, another one will float down the stream.
What Went Wrong?
Recently, I was under contract to buy a triplex in Minneapolis. I signed the purchase agreement in late-February before any of us knew how impactful the COVID-19 could be. At least coming from a person with limited-to-no medical background or experience.
Anyway, signing a purchase agreement for a triplex during a global pandemic is a great learning experience. Especially when you are dealing with a high maintenance and difficult seller. From signing to target closing, we went from having no cases of COVID-19 in Minnesota to a full shelter-in-place. The timing couldn’t have been any worse.
I asked repeatedly to extend closing due to COVID-19 since my wife was tested for it and the variety of changing elements around us. The seller’s “attorney” threatened suit and played the scare tactic game that I’d be in breach of the contract.
In the world of private investing, it’s usually seller and buyer working things out. Attorneys only get involved when absolutely needed or when legal agreements need to be clarified or improved.
Note: I was unrepresented so I had to go out and find someone after getting cornered by an “attorney” (I’ll get to it later). The seller was never involved in the process at all.
Ultimately, the seller did not close the transaction and I ended up learning more from this experience than I would have if the deal did ultimately close. I’ll leave the details to a minimum because I’m not here to vent. I’d rather give lessons learned.
Just because one transaction went wrong doesn’t mean I should close shop on my thesis that real estate is a great asset class to build wealth. I’m here to provide learning tips to potentially improve your perspective on acquiring assets during difficult global macro environments and/or difficult sellers.
5 Things I Learned From a Real Estate Transaction Gone Wrong
Here are some things to avoid on your next real estate transaction to avoid a disastrous situation as I went through.
Be Conservative on Any Purchase
Okay, global pandemics do not happen every single week. But, recessions, layoffs, natural disasters and so much more happen over time. Real estate is a great asset class because it offers pretty attractive risk-adjusted returns.
There’s also a ton of ways for you to develop an investment strategy such as fix and flip, affordable housing, capital appreciation, cash flow only, etc.
However, the moment you get beyond your skis is the moment you can lose your entire balance.
Things do come up and if you are buying a home without having 6 months of reserves, you probably shouldn’t do it. The best part about real estate investing is that each asset acquisition can serve as a base that unlocks additional financial flexibility for you in the future.
You can use a HELOC on a rental property to finance other repairs while you also have reserves. To be clear, I’m not saying use as much leverage as possible and none of your own cash.
I’m saying you can hold cash reserves while using other levers to finance higher returns on your capital. You get a number of low-cost options to use other people’s money to make money.
Use Financial Analysis (And Continually Update It)
My wife continues to tell me that I’m too obsessed with my spreadsheets. It’s probably a bit true. Even if you are buying a home for primary use, you should understand the financials and potential returns on your investment.
For rental properties, it’s even more important. I created a free rental property spreadsheet in Excel that will help you conduct scenario analysis. I built in a COVD-19 scenario into my financial model and it actually showed that I would breakeven on my investment. We don’t invest to break even, of course.
But the model had extreme vacancy rate assumptions (15%), declining rents, and increasing costs. It simply couldn’t get much worse from an assumption standpoint of what I could personally control.
From a downside perspective, that wasn’t too bad. The upside was pretty favorable on the other end.
Know Your Seller
During this transaction, the seller painted a picture that (s)he owned $100 million worth of real estate assets. Turns out this was incredibly false. I only met the seller once and it was at closing. The seller didn’t even come inside closing and only allowed his attorney to be involved.
After doing some homework on his “attorney” and himself, it turns out they are roommates. They also once lived together in the triplex that I was contemplating purchasing.
Whoa. Probably not the first time that has happened in the world, but that is a huge red flag. The “seller” (what I would call likely the attorney and the actual owner together) really only owned 2 properties.
The property I was purchasing was completely paid off, which suggests they had a significant part of their net worth tied into it.
Seller due diligence is crucial. It should be conducted upfront because as you know more, your negotiating skills strengthen and you can understand what type of situation you are getting into. You can do so by looking up the property owner in advance of putting in an offer.
Find a Lender that is Aligned With You (Even If It Costs More)
The mortgage loan market continues to baffle me. In the professional investing world for private equity and private transactions, lenders usually align with other sources of capital to get a deal done.
Why? Everyone is going into the same deal no matter what. If a lender is senior to you, they should have even more comfort about the transaction than you. As an equity holder, you are taking on more risk. But lenders should view the deal with more scrutiny.
In the mortgage market, it doesn’t always work that way. FHA lenders will usually use the government as a backing to their criteria. Additionally, mortgage lenders will securitize your loan and profit. They are not the residual holding of your interest.
So how much do lenders really care about the property? I like a local lender that will view the property exactly the same way as you. You should feel like they are in the same deal as you. Because they are.
Start there and if it means that it costs you more that’s okay. The mistake I made was working with a lender that didn’t even live in my state. They had no concerns about my personal financial situation in light of COVID-19 because they simply couldn’t lose.
The lender had no interest in going to bat for me to ensure we were entering the deal with the same level of comfort.
Coordinate Between Inspection, Appraisal and Your Realtor
Just a quick note — like your lender, you should also have a very trustworthy realtor that will go to bat for you. Lenders and realtors are incentivized by reaching the finish line. Inspectors and appraisers just earn a flat fee for providing their opinion and review.
When you are working on a deal, find the toughest inspector you know. Again with the cost, I’d rather pay more for an intense review than be cheap and miss a massive issue. The moment you discover issues like code violations, miscounted bedrooms, a potential recurring issue, etc., you should coordinate it with your lender so the appraiser is aware during their valuation.
The bedroom count trick is one that way too many people get away with in selling properties. There are a ton of non-conforming bedrooms out there that, by law, are not compliant.
Finally, if you need to hire an outside appraiser not associated with the lender, go for it! It’s a small cost for a relatively large opportunity cost. Appraisals can cost $500-$600, so it’s a fraction of a single percent of the overall purchase price.
As issues come up, stay transparent with the team you’ve assembled. Everyone should act accordingly as a team to get the results that make the most sense for you.
Conclusion
Don’t let investing stress you out no matter the situation. At the end of the day, it’s only money. Our health and mental wellbeing should come first. Some might say they go hand in hand.
But if you don’t care about money too much, you might not let it get to you if it doesn’t go according to plan. Real estate remains an attractive way to build wealth due to the reasons I outlined above. These are a number of factors that we can personally control. Investing in companies on a minority basis doesn’t afford the same luxuries.
The same goes for real estate crowdfunding. You’ll likely end up solely evaluating the condition of the market. You may not have the full control to dictate rents, cost improvements, management fees, etc… I’m still a fan of real estate crowdfunding to diversify but perhaps taking a shot at direct real estate investing can open the door to financial autonomy that opens doors to new financial chapters of your life.
Having control over your own destiny is limited commodity in investing. A global pandemic of this magnitude only comes once every 100 years (let’s hope), so there are a ton of life long lessons that we can use to make better decisions as investors.
Author Bio: Financial Wolves is a blog focused on helping you make more money to achieve financial freedom. After repaying student loans, I’ve shifted my focus to make more money from side hustles, real estate, freelancing, and the online economy. Follow me on Pinterest, YouTube, Twitter, and Facebook.
10 thoughts on “A Real Estate Transaction Gone Wrong – Lessons Learned During A COVID Rental Transaction”
In real estate there is a special term called “force majeure” that might have been employed by buyer to delay closing due to COVID-19 exposure. It can be put into your future sales contracts to cover this type of act of God where a delay is simply unavoidable.
Of course, if you discovered some kind of underlying defect in the property, then the above is a moot point for this transaction.
I also don’t understand why this was a transaction gone wrong. I also don’t understand why the owner and lawyer being room mates is an issue of even of any consequence.
Hmm. I realize it’s light on facts but I would say lessons missed are that a contract is a contract and you should expect to be held to your obligations, don’t expect your bank to have the same interests as yours when they are not actually investing in the business on the same terms as you to become a co-owner, and as a seller don’t count your chickens until the deal has actually closed because your buyers might try to transfer their risk to you before closing.
I, too, am confused as to the facts of the story.
Why was this a transaction gone wrong.
Without understanding the basics of the story, it’s hard to draw any conclusions / learn any lessons.
Thanks for sharing, some really great tips! Especially the one about inspections and appraisals – it is easy to skip if you are not getting a loan, but this due diligence is so important. Super curious to know happened in that you got to the closing table itself, but then it didn’t close…
No matter the price point or situation, you could end up with a flaky seller and it can be really hard (if not impossible) to tell until you are already under contract! Flaky sellers can even have a reputable attorney.
The process of closing real estate is so different depending on the state you are investing in and size of the asset, among many other things. Some states are ‘attorney closing’ states, where attorney is required, but most are not. Often times closings are just done by title companies, so many times buyers might find themselves without an attorney and then have to scramble to find one if a dispute comes up. Obviously the higher the price point (don’t know how much your triplex was) the more likely you will want your own attorney and go for that added expense.
Ideally you have a good realtor looking out for your interests, but given the fee that the seller has to pay to them, realtors are only usually involved if the property was listed on the MLS, and these days (at least prior to COVID-19), finding MLS deals is difficult. Many deals are done directly with wholesalers or owners selling on their own who don’t want to pay that extra realtor fee.
Great advice. In particular, running a downside case is crucial -‘ and yet, very few buyers do it.
I can’t count the number of times I’ve seen cap rates that assumed 100% occupancy, highly optimistic opex assumptions, and no maintenance.
I’m not clear on what the problem was. You got cold feet because you didn’t want to buy in the middle of the pandemic. Okay. So why is that the sellers’s problem? You had a contract, you wanted out, and they seemingly tried to make you adhere to the contract. That seems reasonable. So what if the seller and attorney lived in the same building or if the building was paid off? How does that factor into the fact that you had a contract to close by a certain date and you wanted to extend it despite their reasonable objections. You are not the only one affected by the pandemic. Everyone has a story and it is valid. Is there more to this transaction you are leaving out? Was the building misrepresented in some way? Presumably if you did your due diligence which I assumed you did, you should have honored the contract which is to say either close or forfeit the earnest deposit and thank them for their time.
It sounds like you’re misconstruing the author’s perspective. He never said he wanted out of the deal. Sounded to me like he wanted to postpone it because he had been exposed to COVID-19 through his wife and likely didn’t want to contribute to the spread of the disease. And, it was the seller who ultimately backed out of the deal so it appears the author did honor the contract. Admittedly the transition from the opening to the lessons learned was a little rough because we didn’t actually need to know that the sale fell through for the author to share the lessons (and because most of us really do love to hear the scandals involved of crazy sellers.)
Colleen – That is fair. Maybe the juicy stuff can be a Part 2… 🙂
Astrid – There is some more to the story that I left out. I didn’t think getting into the ins and outs of it would solve anything. Like you are saying they likely have their perspective and I have mine. I wanted to focus on what could be improved for next time.