The Radiologist’s Guest House Fiasco: a $300,000 One-Bedroom in the Woods

Often, I share tales of successful investing and real estate ventures. This is not one of those. It’s quite the opposite, in fact.

No, this dumpster fire of a deal was one of a number of money mishaps endured by my radiologist friend back when he was married to his first wife. To say that he does not reflect fondly on that relationship would be far too subtle. For more on why he does not speak kindly of his former spouse, read his take here and here to learn how the divorce set him back at least $850,000.

While this is one of those train wrecks that you can’t look away from, it does have a reasonably happy ending.

 

 

 

Long time readers may recall that in 2005 a certain Ebay listing changed my life.

What might have been an impulse buy subsequently created a cascade of dominoes that ultimately turbocharged my net worth in ways I could not imagine at the time:

• Taking advantage of Geoarbitrage by relocating to an extremely low cost of living area, with no state income tax as a bonus.
• Joined a medical practice that not only prioritized lifestyle (I have no call, no nights, no weekends, with the majority of the time enjoying a 4-day work week) but also gave me access to what I consider the best investment I have ever made.

 

When I purchased the property with my now ex-wife, there was only one dwelling located on the 7.67 acres.

My ex-wife had expressed her desire to build a guest house on the property so that her parents, who lived in England, could have an extended stay when visiting their granddaughter and us.

It just so happened that there was a perfect building site for a guest house that, because of an intervening change in elevation and vegetation, would be out of sight but still in close proximity to the main house.

I was shown blueprints of various home designs and we eventually settled on one.

Because the home was primarily designed with her parents in mind, it ended up being a 1 bedroom (located on the main floor), 2 story structure with a loft on the 2nd floor.

This was pretty much the only part I was involved in because, as a full-time radiologist, I had no desire to oversee the building of the guest house.

Apart from a few small incidentals during construction, I also was not financially involved in the project as her parents, my now former in-laws, provided all the necessary funds.

 

The construction fiasco

 

Things initially started out smoothly.

My ex hired a general contractor who had a great reputation in a neighboring city.

However, things turned sour quickly, which was quite understandable given how my ex interacted with people.

She fired the contractor within the first 6 months of the build and thought that she was qualified enough to take on that role herself.

My ex’s experience with any type of home construction was sparse at best.

She had renovated a bathroom in her previous London flat prior to marrying me.

She also oversaw the renovation of a 1 bedroom downtown condo I had purchased (for $55,000) for rental purposes.

I know I overspent on the renovation by letting her take the reigns of that project, which ended up costing over $30,000, because she has very expensive taste and has no problem spending money she did not earn.

This rental was geared towards college students but that did not prevent my ex from loading the place with high-end appliances including a single-unit hybrid washer/dryer unit from Europe. [PoF: Having used a bunch of these in Europe and elsewhere, I can assure you that the promise of a washer that actually dries your clothes too, is a false promise.]

On top of the initial higher price tag, I ended up spending 100s of dollars more in repairs over the years as this unit was quite finicky and carried higher costs in replacement parts and labor than its domestic brand counterparts.

I was not confident in her ability to construct a house from the ground up but, since it was not my money pouring into the project, I kept quiet.

My low confidence level ended up being right on the money as the construction project dragged on for years (I believe from start to finish it took over 3 years).

Mind you we, were constructing an approximately 1,400 square foot 1 bedroom home, not some luxurious mansion.

I also questioned how my ex selected subcontractors and general help.

It would not surprise me at all to find out she just used day laborers for the entire process rather than relying on licensed subcontractors (more on this later).

 

Fortuitous timing for my divorce

 

I filed for divorce at the end of January 2010 after coming home from a disastrous Disney vacation with my ex.

Although I did not plan it, I was very lucky with the timing in more ways than one.

The biggest bit of luck was that the guest house construction was completed by the time the year-long divorce proceedings concluded and I had assumed full ownership.

It would have been painful and costly to figure out what projects were completed and what still needed to be done if this was not the case, especially since I would be inheriting the issues at ground zero with absolutely no guidance from my ex.

The second fortuitous event with the timing of my divorce was that, in 2010, the housing market was still trying to recover from the great crash.

That meant real estate prices were far lower than in prior years (or subsequent years for that matter).

Because of the depressed housing market, I was underwater in terms of the value of the entire property with respect to my mortgage.

Because my ex would not go after an asset that carried negative equity I received the marital property without her contesting.

She knew how much I loved the property so it must have pained her to see me end up with full ownership of it.

Her mother tried to recoup the money she put into the building of the guest house and filed a petition with the court that was incorporated into the divorce hearings.

Her mother hired a separate lawyer and they wanted me to pay for “improvements on the property” regarding the guest house construction.

Her lawyer presented a detailed expense sheet with receipts etc for all the costs incurred by her mother.

It turned out that she spent over $300,000 building the guest house.

I truly believed these numbers to be true given my previous experience with her daughter.

It certainly was a strange build, to say the least as my ex had put her expensive flairs all throughout the home:

• 3 full baths despite only being a 1 bedroom home.
• Expensive marble tiling throughout, including in the interior of every closet.
• An immense master bathroom with a large water closet containing a high-tech toilet and separate bidet, a monstrous rainfall shower,  and a separate high end whirlpool tub.

 

There was no way a 1 bedroom home in a rural setting was worth $300,000 and the court-appointed appraiser agreed with me, citing that the building itself added $90,000 of value, which was likely deflated because of depressed real estate values everywhere.

The appraiser did mention that the finishes of the guest home, particularly the master bathroom, surpassed those of the primary home just to point out the extravagant nature of my ex and her building choices.

The judge then ordered me to pay 1/2 ($45,000) to my former in-laws.

My ex was ordered to pay $45,000 to her mother to make up the difference, which I truly believe did not happen.

To add some salt into the wound, I found out after the divorce that there was a lien placed on the property by the original general contractor who apparently did not get paid inn full by my ex.

I ended up settling the lien for $20,000.

 

 

The rental phase

 

With the original use case of the guest house no longer in play, I decided the best option would be to rent it out.

I did not want to have a house sitting empty, even if it was only a couple hundred yards away, as homes tend to deteriorate more rapidly if left uninhabited.

Fortunately, I was able to rent out the place fairly quickly.

In the beginning, there were numerous problems encountered with the property that called into question the workmanship.

Some of the plumbing was hooked backward, with cold water coming out of the hot faucet and vice versa.

There were also some electrical issues that I had to get a licensed electrician to get corrected.

The electrician actually told me that whoever put in the wiring really did not know what they were doing and it was a tangled mess.

The property was located at a higher elevation with a long gravel driveway (over 1,000 feet).

There was no proper drainage put in place alongside the drive and the tenant would often complain that the driveway became impassable after a storm on numerous occasions.

Eventually, I decided to bite the bullet and spend $12,000 to have a more permanent solution put in place.

My ex-wife’s tendency to buy foreign, expensive, appliances also continued with this build which also led to further costs when they inevitably broke down.

Several years into the rental I was informed that the stand-alone bidet was no longer working/damaged (to be honest I was surprised it was even being used).

I had to hire a plumber and, with parts and labor, the project cost me over $2,500.

You would think that with all these high-end fixtures and finishes, I would be able to charge a premium on rent.

However, we were in a very rural location.

The home was way overbuilt for the area, and it only technically being a one-bedroom also severely limited the rental pool.

The renter remained in place for over 10 years with the average rent coming in at around $700/mo.

There were periodic increases in rent, with the final monthly rent topping in at $825/mo.

While most of the maintenance expenses/repairs occurred in the early years, ever so often I would be hit with an unexpected large expense:

• Needing to cut down trees that were damaged in a storm ($1,000)
• Replacement of the fancy master bedroom shower system that went on the fritz with difficult to find replacement parts required ($800)
• Cracked glass electric stove surface ($1,000)
• A snake short-circuiting the HVAC system ($400) in winter when it tried to find a warm place
• Having to re-do major duct work ($800).

 

Time to cut my losses

 

I knew the property really was not cash flowing even under the best of circumstances:

• Rental Income of $825/mo x 12:  $9,900
• Income tax (37%): $3,663
• Property Tax: $2,100
• Insurance: $1,300
• Net Income: $2,837 or $236/mo (I did benefit from depreciation on my taxes which I did not include here)

 

I also knew that, as the property aged, more issues would start to crop up requiring even more cash infusion, obliterating what little, if any, positive cash flow this property produced.

I therefore informed the renter that I was exploring options to sell the property.

The renter actually was interested in purchasing the property and asked how much I was thinking of selling it for.

We came to an agreement at a sale’s price of $125,000.

I honestly do not know if the true market value was higher or not, but I thought a direct sale to the renter would be the most convenient option and was willing to leave a little money on the table if there was any.

 

My selling checklist

 

My first item on the agenda was to formally subdivide the property, which required a formal survey.

For a property this size (7.67 acres) the survey ended up costing $1,000.

I then had to submit the proposed subdivided plots to the county commissioner for approval.

Typically each parcel of land where I was located had to be a minimum of 5 acres, which would not be possible in my case.

Fortunately, I did not run into any issues and the approval was given with only a minimal application fee required.

I went to the title company that I used when I first purchased the property and asked them to prepare deeds for the component I was keeping and the component I was selling ($200).

Since I already had the buyer in hand, I felt it unnecessary to use a real estate agent to broker the deal, saving 6% on real estate commissions.

Taking into account the savings on commission, it was the equivalent of me selling the property for $133,000 if I went the traditional way.

I was about to hire a real estate lawyer to draw up the contract and had called the title agency to see if they had anyone they recommended.

The representative said that they could provide a standard real estate contract free of charge which would obviate the need for a lawyer, probably saving me another grand or so.

 

Discarding the Albatross around my neck

 

With all the paperwork completed the transaction itself was very smooth.

The seller paid for the property in cash (technically, he borrowed it from his parents).

My closing costs amounted to $325.

In addition, I had to pay a prorated amount for the property tax which by late August amounted to $1,400.

I received a cashier’s check for $123,000 which I directly deposited into my bank.

Even though the cashier’s check was directly from the title company, US Bank still put a 1 week hold on it.

 

Tax Consequences

 

Prior to closing, I contacted my CPA so I could anticipate what kind of tax implications the sale of this property would carry for me.

According to my CPA, throughout the years of renting I took advantage of $46,000 of depreciation.

He felt that even factoring in the depreciation, my cost basis was higher than the sale price (based on the guest house being gifted to my ex-wife at the $300,000 cost basis and then the property was awarded to me) and I would not owe any capital gains tax.

He also said that in case there were capital gains at play, I had more than enough (over $400,000) suspended passive income losses (using depreciation from all my other syndication investments), to offset it completely.

 

Redeployment of Capital

 

I knew I had to do something with the large infusion of cash as I just did not want it sitting in my savings account earning a paltry 0.5% interest.

Given the fact that recent monthly inflation rates were over 5% I was losing purchasing power by just sitting on it.

Because this money came from the sale of a real estate asset, I wanted to plug it back into that portion of my portfolio.

I ended up committing the entire proceeds into the Origin Income Plus Fund, a fund I have been invested in since 2019. [Disclaimer, Origin Investments is a sponsor of this website.]

 

I chose this particular fund for the following reasons:

• I am a current investor and have had great experiences with the principals involved (who also have each invested over $5M of their own money into the fund).

• I love the open-ended nature of this fund which has a buy and hold forever policy regarding multifamily assets.
  • Although other funds tout higher returns (IRR), these deals typically have a 5-9 year lifespan.
  • At the end of the fund cycle the investor is faced with the dilemma of how to redeploy the money as well as having a taxable event.

• The Income Plus Fund pays out monthly distributions (which other syndicators typically do on a quarterly basis), which amount to 6% annual return.
  • These monthly distributions can smooth out cash flow peaks and valleys when I do enter my retirement drawdown phase.
  • Origin offers a distribution reinvestment option as well (which I am currently taking advantage of while I still earn W2 income) similar to a Dividend Reinvestment Program (DRIP) seen in some equities.

• In addition to distributions (which is the Income component of the fund), the Plus in the fund’s moniker refers to growth of the contained assets, which are assessed on a monthly basis to give a Net Asset Value (NAV).
  • The investor can then redeem any or all shares at the current NAV value (there is a lockout period which I believe is 5 years after which there is no penalty fee for withdrawal).

 

[PoF: I am also invested in this fund. You can see my returns from this investment and several others in my recently updated My Many Real Estate Investments.]

 

How the numbers play out

 

If I had not sold my guest house and continued the rent at $825/mo, I would have grossed $9,900 and netted $2,837 ($236/mo) based on the numbers provided above.

Although I received $123,000 in proceeds from the sale, I committed $125,000 to the Origin Income Plus fund.

Based on the fairly steady monthly distribution rate (6% annual), I should receive $7,500 ($625/mo).

While this amount is lower than what I receive in rent,  based on depreciation and other tax advantage maneuvers the fund makes use of, this cash flow is essentially tax-free to me and thus my net is much higher ($7,500 vs $2,837).

As a bonus, I do not have to deal with headaches of managing the guest rental or be hit with unexpected repair costs.

Selling my guest house also helped sever the last major tie of my ex and her projects from my life.

This was definitely a win-win situation for me.

 

 

Have you had any real estate headaches? What words of wisdom can you share? How did you resolve it?