5 Lessons I Learned When I Walked Away From a $10 Million Deal

by | BiggerPockets.com

Warren Buffett famously said, “The difference between successful people and really successful people is that really successful people say no to almost everything.”

I’m starting to feel like Warren Buffett in this regard.

Though I spent much of my career jumping at opportunities in front of me, I’ve become very cautious in the investment realm since I turned 50. (Yeah, I know… I don’t look a day over 40. Stop! You’re making me blush.)

My cautious nature was put to the test recently when I was partnering with approximately 40 of my company’s investors to purchase a profitable self-storage facility in a different state.

This is the story of how I flushed thousands in legal fees, sacrificed hundreds of thousands in profits, and risked having egg on my face in front of over a thousand people on my email list—all in the name of being cautious and protecting my investors and myself from potential risks.

Why I Walked Away From One of the (Potentially) Most Lucrative Deals of My Career

A few years back, I wrote a book. Attempted comedy alert: with great humility, I titled it The Perfect Investment: Create Enduring Wealth from the Historic Shift to Multifamily Housing. 

But I’ve come to believe that for conservative investors, multifamily has gotten largely overheated in this real estate cycle. For many of us, it is hard to find a deal that makes sense.

(I readily admit that some companies are doing a better job than mine in sourcing deals, and some are getting good ones.)

As a result, my company and I have begun investing outside of multifamily—more specifically, in self-storage. I’ve detailed my logic for this expansion on BiggerPockets in the past.

Related: The Multifamily Sector is Overheated—So I’m Turning to THIS Profitable Niche Instead

In the spirit of providing low-risk opportunities for our investors, we have been carefully vetting successful self-storage and mobile home park operators. We’ve been looking for operators who thrived during the last few market downturns and who we have confidence in at this point in the market cycle.

We have now vetted three operators for whom we have great respect. We have visited each of them in person multiple times, and we plan to take advantage of more investment opportunities with each of them in the coming months.

One of the operators recently approached us with an opportunity to recapitalize an asset they’ve owned since 2012. Another investment group had long planned to exit.

This asset is in a great location, with strong population growth and high incomes. The risk seemed very low since they have been in operation for six years and are aware of the challenges, costs, and market dynamics. The market study and financials on the property were strong, and we were excited to do our second investment with this operator.

I was speaking at a D.C. conference, then flying out to L.A. to interview two more self-storage operators a couple days later. We decided to get the legal docs together and announce the webinar to our investors before I made a trip to see it in person.

I returned from L.A., then I immediately boarded a plane to see the asset. I spent a day touring the area, the asset, and each of the comparable properties. I visited the city’s Planning and Zoning Department and reached out to the neighboring city and the county building departments, as well.

When Visiting a Prospective Investment, What I Found Surprised Me

During my visit, I learned that two new permits had recently been approved for large self-storage facilities nearby. One was just a tad over two miles away. Upon driving to that location, this is what I saw:

 

I was alarmed—to say the least!

The construction of the two large facilities (about 80,000 and 100,000 square feet, respectively) verified our belief that the growing market would support more supply. Errrr… great news!

And it would be easy to justify moving forward and even bolstering our argument for the market’s strength. (There are always mental arguments to support what we wanted to do anyway, right?)

My first thoughts were something along the lines of:

  • This is a strong, cash-flowing investment with an established presence in a market where the population has grown by 10 percent since 2010.
  • Storage tenants are “sticky” and will rarely spend a Saturday to rent a moving truck and move their stuff down the road to save a few bucks per month (especially when they only plan to be there a short time).
  • Our investors are hungry for more investment opportunities, and we’ve already announced this one! We stand to collectively make a lot of money on this deal.
  • We’ve just spent several thousand in attorney’s fees preparing our legal documents.

close up of hand holding yellow post-it reading say no

What Would Warren Buffett Do?

But that’s not how Buffett thinks.

I don’t want to place our investors’ capital at any unnecessary risk. I have a lot of confidence in the operations team for this company, but we decided to pass on this opportunity.

The deal would have probably turned out fine. But our role is to carefully screen operators and opportunities and to protect our investors and ourselves from all avoidable unknowns and risks. This specific opportunity probably just isn’t good enough.

With the revelation of these new facilities upon my visit to the area, this investment became too risky for us. What’s more? I am genuinely convinced that the operator was unaware of these new permits. It is very hard to squeeze information out of building departments—even for pros.

Related: Introduction to Real Estate Investment Deal Analysis

What I Learned in This Instance—and What You Should Learn, Too!

5 Takeaways From Touring an Out-of-State Investment Opportunity

  1. Always do your own due diligence. Do this on the ground. It’s not enough to study market reports, Google Maps/Google Earth, etc. I learned this after almost making a terrible mistake in an apartment deal a few years back! And I know a lot of investors have been burned buying out-of-state turnkey homes sight unseen.
  2. Check everything with local planning and zoning/building departments. Be sure to do this whenever it’s relevant, but don’t limit yourself to that. Drive every significant road within a reasonable radius to see what’s going on yourself.
  3. Use the “grandma rule” for investing. Don’t allocate a dollar of your money—or an investor’s money—toward anything you wouldn’t recommend to your grandma if it was all she had to live on. (And, of course, never take any investor’s capital if it’s all they have to live on.) This was taught to me by my multifamily mentor.
  4. Don’t be afraid to walk away. The fallacy of sunk costs can lure you into moving forward. (i.e., “but we’ve already invested so much time and money!”), but this siren song needs to be passionately ignored.
  5. Sometimes the best deal is the one you don’t do. It’s just a fact: “You’ll never lose money on the deal you don’t invest in.”

We started with a famous Buffett-ism. Let’s end with Buffett’s first two rules for investing:

  1. Rule No. 1: Never lose money
  2. Rule No. 2: Never forget rule No. 1.

Have you ever walked away from a deal that looked good? Or have you ignored your instincts and plowed forward anyway? How did it turn out for you?

I’d love to hear from you in the comment section below!

 

About Author

Paul Moore

After graduating with an engineering degree and then an MBA from Ohio State, Paul started on the management development track at Ford Motor Company in Detroit. After five years, he departed to start a staffing company with a partner. They sold it to a publicly traded firm for $2.9 million five years later. Along the way, Paul was Finalist for Ernst & Young's Michigan Entrepreneur of the Year two years straight. Paul later entered the real estate sector, where he completed 85 real estate investments and exits, appeared on an HGTV Special, rehabbed and managed dozens of rental properties, developed a waterfront subdivision, and started two successful online real estate marketing firms. Three successful developments, including assisting with development of a Hyatt hotel and a multifamily housing project, led him into the multifamily investment arena. Paul co-hosts a wealth-building podcast called How to Lose Money and is a frequent contributor to BiggerPockets, producing live video and blog content on a weekly basis. Paul is the author of The Perfect Investment—Create Enduring Wealth from the Historic Shift to Multifamily Housing (2016) and is the Managing Director of two commercial real estate funds at Wellings Capital.

11 Comments

  1. Kevin McGuire

    Paul, always appreciate your posts and your approach to real estate investing.

    I think sunk-cost bias is the biggest psychological trap for investors. And, generally in life. Just last night I was coaching a friend who is considering leaving her job. I applied a thought experiment which I learned some time ago and which I find extremely effective:

    “Knowing what you know today, would you take this job?”

    You have to imagine you don’t have the job, but you have the benefit of knowing lots about it. Would you take it? If no, then tells you maybe you shouldn’t stay in it.

    Similarly I apply it to stocks. My employer provides a significant portion of my compensation in stock, as did my previous. People get all confused trying to figure out whether to hang onto the stock or not. I turn it around and ask myself, “If they had given me cash instead, would I buy all this stock right now?”. Taxes aside, the decision to hold a stock is the same decision to buy it; if you pretend you have the cash instead, and you wouldn’t buy the stock, why are you holding it? We make weird decisions.

    In your case, the legal fees were already spent, your time investment was already spent … they’re irrelevant when it then comes to making the investment decision. Taking a bad deal won’t get those back!

    To your question, I personally have walked away from two deals that looked good. In both cases I applied that thought experiment,

    “Let’s say this deal is just now being presented to me. Knowing what I know about it, would I take it?”.

    In the first one I didn’t like the status certificate of the HOA. My agent really liked the property and had invested a lot of time on the deal, but the deal was too skinny to begin with due to the HOA fees, and the status certificate showed HOA under-funding and potential future expenses due to water infiltration and settling of some units. I just felt like I was buying someone else’s problem. It took a lot to say “no”, and I know my agent was disappointed (disclaimer: he’s my dad, so that really added to the pressure!”).

    In the second deal, it was a fourplex and we noticed the taxes seemed low. With further digging we discovered that the place had been renovated into a fourplex but the city still had it listed as a duplex. The seller tried to convince us that the city would likely not notice for some time. We estimated the true taxes and it was no longer the cap rate I was looking for. It was a great place, and the deal was now ok but not great, and I was concerned that, since this in my mind amounted to a misrepresentation on the seller’s side, other material matters might be hidden. It still pains me that I walked away because I really liked the property, and felt bad that my agent and property manager had invested a lot of time on it, but again you have to zero all that out when making the decision. Wishing it was the deal I wanted and not the deal I had amounts to magical thinking. Not a good investment approach!

    Two books I’ve really liked that readers might find relevant:

    “Mistakes Were Made (But Not by Me): Why We Justify Foolish Beliefs, Bad Decisions”, and Hurtful Acts, by Caroll Tavris, Elliot Aronson

    “Influence: The Psychology of Persuasion”, by Robert B. Cialdini PhD

    The first one in particular seems relevant for your excellent podcast, “How to Lose Money”.

  2. Christopher Smith

    In Warren’s world your deal was at risk of losing it’s Durable Competitive Advantage (DCA) with the introduction of new competitors.

    Before the internet, Warren loved to invest in single Newspaper markets because of the huge DCA tjos

  3. Christopher Smith

    In Warren’s world your deal was at risk of losing it’s Durable Competitive Advantage (DCA) with the introduction of new competitors.

    Before the internet, Warren loved to invest in single Newspaper markets because of the huge DCA those papers had. However, if the market had multiple news papers it was almost certain to be at best a mediocre investment regardless of how well run. So he was NOT interested.

    • Paul Moore

      That’s right Christopher. Thanks for your comment and for connecting this to Buffett’s strategy. I wouldn’t have thought of this. I’m reading “The Snowball” right now (Buffett’s Bio), and this is a helpful connection.

  4. Cheryl Vargas

    Great article @Paul Moore!
    One thing I would like to know for when I talk to the planning departments in the future—
    What were the specific questions that you asked them in order to find out other building projects going on that would interfere with your planned purchase? How do you get information from them?
    Thank you!

    • Paul Moore

      Cheryl,

      It was actually quite challenging. I called two people and asked them multiple questions. I went in and spoke to someone in person. Their first question was, “Give me the address and we’ll tell you what is planned for that location.” Of course I said, “I am visiting here from out of state. I have no address, and I don’t know if any self-storage projects are planned at all. That’s what I’m asking you.”

      Later I got a tip from someone at another storage facility who told me about one being planned on a certain street. I drove around that area until I found it, then I called the planning department back, and they confirmed it.

      Buffett calls it getting the scuttlebutt, and that’s the main thing to do I think.

  5. Andrew Jurinka

    I think the points you make are valid, but they apply to any deal. How they applied to your deal would be worth knowing. What exactly changed your mind. The presence of a new development wouldn’t necessarily be enough to drive me away from a. deal. For example, in multi-family, a new “A Class” project that has a higher cost basis than my property, will appeal to a different demographic than my older “C Class” property that will always be priced lower than a newer property. Even if my asset was the same as what was being built, if a region is growing and incomes are rising, and product is being absorbed quickly, then it’s likely that all boats would continue to rise. Since you’re dealing with self-storage now, I would want to know more about the competing facility and all of the details that goes into the decision making of the customer. What specifically about the new project would have made customers choose their facility over yours? It is worth adding to anyone’s dd checklist, “would this deal work if someone built nearby/next door?” You could have easily bought this property and six months later someone applied for a permit to build. Then what?

  6. Paul Moore

    Thanks for your comments and questions, Andrew. I may not have clearly explained it, but the two new facilities were much better located than this one. This one had very limited visibility from the main road, which I had not recognized online.

    And these new facilities threw the supply and demand balance way out of whack. We are looking for locations where there are about 7 square feet of storage per person in a 3 or 4 mile radius. That was about the ratio before the new facilities were added. But with these being added, the numbers were way off.

    Furthermore the new assets were being built and run by professionals, not mom-and-pops. They would out-market and out-perform us all day long.

    As far as a new facility coming online later, that is one of the major risks in this business. The major risk. Hopefully competitors in this already overheated market will generally be smart enough not to build when the demographics won’t support it.

  7. John Canchola

    Great read. I learned something from it . Also, great probing questions from the other members. Its great roundtable discussion. After all this studied information, I still see others would be giving this venture a go. Interesting as to how many versions and opinions one can get from looking at the same project. It’s why I really enjoy reading BP threads.
    Thank you for sharing your time Paul.

  8. Ken Bailey

    Hi Paul,
    Excellent read and always enjoy anything Warren Buffet says. He’s the real E.F. Hutton to me. I’ve always had a thing for storage facilities. The accounting for my CPA would be much easier. Anyway, thank you for words of wisdom.
    Ken Bailey

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here