How to Exit a Real Estate Deal Gone Bad
I’m pretty sure that every real estate deal we go into looks rosy in the beginning. The numbers look good, the property looks good, the market looks good, and the cash flow looks good.
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Then maybe some time goes by, and you’re standing there wondering what went wrong. I know I’ve been there. While it could be the case where we made an error in judgement when entering into the investment, often something changes that’s outside of our control.
So, what are those possible changes, and how do we stay on top of them?
Evaluating Your Portfolio
Regardless of what you invest in, I think it’s prudent to periodically evaluate your portfolio.
I review both my properties and my notes at least on a quarterly basis. My notes are probably easier since I get statements from my mortgage servicer, and I only invest in performing notes on a personal basis. As for my real estate, I have a property manager also send me monthly statements with everything collected and all the expenses we’ve encountered broken down, so that part is pretty easy.
When it comes to portfolio analysis, though, it’s really up to us as investors to adjust our strategy when needed. For example, my mortgage servicer doesn’t tell me the best time to sell a note. Maybe it’s best to sell when equity is up in the marketplace, when there’s more than 12 or 24 months of payment history, when there’s less than a certain number of payments remaining, or when you’ve already collected back your initial investment. You get the idea.
Well, it can work similarly for real estate. For me, I look at my properties’ location, cash flow, condition, appreciation potential, insurance expenses, taxes, and aggravation level at least yearly. (Does anyone look at aggravation levels besides me? This can include the level of difficulty for renting it out.) I also look for strategies to increase profitability and cash flow, if possible.
To be honest, in over 25 years of owning rentals, I’ve had almost everything that can negatively impact a piece of real estate happen to me. I’ve had property values drop. I’ve put three kitchens in the same unit in a 10-year period. I’ve had abandoned cars, units burn down, tenants get incarcerated, and even an attempted murder in one of my units. I’ve had a SWAT team and the DEA destroy units. I’ve had natural disasters like floods and trees crashing through the unit.
But, I’ve also had good times too, with many good tenants staying over 10 years.
It’s a numbers game that comes with the territory. Like Tony Robbins says, “It’s not about resources, it’s about resourcefulness.” Sure it helps to have reserves, but it’s not about what happens to us as landlords, but how we react to what happens.
Oftentimes, I look at my properties to figure out how I can improve things. For example, I may renovate or add a bedroom to increase rents. Maybe I’ll rent the garage separately or drop a prefab garage on the property. I’ve even built garages on a lot behind one of my multi-units, which dramatically increased the value and appreciation potential.
I’ve also taken out lines of credit on rentals to tap into the equity and use it to reinvest in other real estate deals, but I mostly use it to do hard money deals for fellow rehabbers and to buy notes. I really hate to see all that equity (from market appreciation and from paying down of the mortgage) just sitting there idle and underutilized.
Pulling Off the Band-Aid
Sometimes the property has just turned into a loser. Maybe the cash flow is down due to higher taxes and township inspection fees. Or maybe the maintenance is so high because it’s an older property that’s becoming a money pit. I had a property once where the flood insurance got so high it just wasn’t worth keeping. Sometimes you can no longer make lemonade out of lemons, and it’s time to cut your losses.
There are other times when I look less at how the individual property is doing and more at how the entire portfolio is looking, especially if they are good properties in good areas.
It’s not necessarily a bad strategy to have your high cash flow, low value (or appreciating) properties help pay for the good properties. I have a good friend whose note portfolio’s cash flow helps to maintain his real estate portfolio. This strategy can work really well in some places like California, where real estate may not cash flow as well but has a lot of potential appreciation.
How You Leave the Party
But how you exit the deal can be just as important as the investment you choose. Sometimes it is how we sell that makes the biggest difference.
I remember my mom had three houses that by retirement had doubled in value. They cash flowed alright, but mom was sick of the ongoing maintenance and management. (To be quite honest, I was getting tired of hearing about it, too.)
Related: What’s Your Exit Strategy? A Case for Converting Your Real Estate to Paper Assets
So, we sold the properties with special terms to other real estate investors. We carried a second mortgage for five years, interest only, with a seller’s assist, and this allowed the buyers to take over mom’s properties with no cash out-of-pocket. Plus, the properties still cash flowed for them.
Mom didn’t have to pay any real estate commissions, she got out of the maintenance business, and she continued to cash flow (from the notes) on properties she no longer owned. She no longer had earned income in retirement, so she didn’t miss the little bit of remaining depreciation very much. This was a great way to exit, and it worked very well for all parties.
In addition to selling with terms like mom did, there are also other strategies available. If you’re not cash flowing enough but there’s significant equity, you could increase your yield by refinancing and reinvesting that capital (as I mentioned before) in something that cash flows more. Of course, you can sell the property. If you take a loss, you may be able to offset other gains somewhere else in your portfolio. That being said, deciding upon the right strategy is really up to the individual and depends on their situation.
I’m curious to hear from some BP folks – what’s the turning point for you that means its time walk away from a deal? What is your favorite strategy for leaving the party?
Let me know with a comment!