Disappointment right before closing (inspections/roof issues)

39 Replies

So we're about to close on an 8-unit apartment building at $250K, no money down and seller-financed at 6%, 5-year term, 30-year amort. The plan was to fix it up, normalize rents, and refi out with a standard banknote as the building is appraised at $305k while about 17% under market rents. We were hoping to refi with 20% equity and nothing out of pocket, and get the land note converted to standard financing where we could build a reputation with the bank and get ready to grow into more properties.

In the inspection it was noted that the roof didn't look great, there were a couple mold spots in two of the apartments, and there was a noticeable leak in two places.  It's a flat rubber roof with rock covering it, and pretty large - 5K sq ft probably. 

I decided to get a few roof guys up there, and they tell me the roof is shot. Bids came in from $30k to repair seems/flashing, etc, all the way up to $70k to completely replace the roof. To make matters worse, while I was there meeting with one of the roof contractors I got to meet with a tenant in one of the apartments, where she showed me that a leak in the roof had filled up one of her light fixtures in her bathroom, burning that out as well as the bathroom fan, and causing paint to bubble on her wall and ceiling. Who knows what kind of troubles we might uncover if we really dig into this. 

How would you pros recommend we proceed? I think the owner, who's pretty laid back, would suggest we hire a handyman and patch a few places, re-paint and fix the fixtures that were burnt out, and he would think he could get it all passable for $3-5k. Do we do that, or negotiate more from the selling price with the plans to get the roof more permanently fixed?

Part of me wants to just do the minor fix and see if we can't make it passable for a year or two while we build up reserves. We've got $25k set aside for max budget on improvements right now, so we wouldn't be able to afford a total overhaul. 

As a side note, what's our worst-case scenario here? We're buying it contract for deed in an LLC, and I believe since the LLC/partnership will have a contract with the previous owner, it's non-recourse on us personally. This is our first property, and we don't want to fail. If we ran it for a year and worst-case a renter who's unhappy with us attempting to raise/normalize rents reports the leaking roof, we could be stuck with MAJOR repairs that we can't yet afford, or who knows, a condemned building because there's mold in that roof/attic/walls that have been leaking.

It's discouraging - we could walk away and take our $25k and go 20% down on a duplex that cash flows $300 a month, or we gamble on this place where the cash flow is approaching $1.5k per month after budgeting conservatively with the bigger pockets calculators. 

Thanks for any input you can offer. 

@Kevin Mosier I don't know all the details on this deal, location, neighborhood Class C or D, etc... However based on what you've written, there are way too many red flags here, I'd suggest looking for a better deal. How many deals did you underwrite before settling on this deal?

We analyzed quite a few, twenty or so, but this is the first one we've gotten an accepted offer on.

I suspect your getting  a No money down owner finance becasue the owner knows exactly whats up.

and is laying off it major cap ex on a couple of newer investors

I would make sure it you had to replace the roof and flat roofs are a bear I would think especially in snow country.. if you don't plan for it you could find yourself upside down.

and thats a good though even though you dont have any personal exposure.. seems like it could be a major time suck.

and for sure you dont want to refi out unless that thing is totally fixed then your putting your credit on the line and maybe PG's as well.

sometimes no money down owner finance you will find that as i state are really not that great of deal your simply buying into major issues.

Yeah I think you're right, Jay. I'm having dinner with the seller tomorrow to get a little feedback from him as to how he's willing to negotiate. If we have to walk, we walk. Just a bummer this late in the game, but some would say it's good to walk away this early I guess. 

I am with Jay, sounds like you found a seller finance deal with $50k in equity because it needs $50k in repairs.  If the roof is that bad you will likely need quite a bit of work just to get to market rent.

A 4 plex I purchased had under market rents bit it was largely because of the condition.  Tenants were fine with it at the price to get better rents we had to complete minor renovations on the units but we factored it into our analysis.

I suppose this is a learning opportunity. I'm just not sure how far the guy is willing to negotiate.

He bought the place for $190K and has been collecting $4700/mth for quite a while, he's owned it for 12 years, but I guess this is what deferred maintenance looks like. 

Approach the owner with a deal that works for both. Roof gets fixed at 50/50 shared costs or whatever works for you. If owner won't negoiate then walk and keep looking. There is more liability for you in this deal than you realize.

You mentioned you could cash flow a duplex around $300. Assuming cash flow is your goal, could you buy more than one duplex in your area with your cash? Could you split that into a couple duplexes and cash flow $600? On one hand, sometimes in RE you have to roll the dice, but you do need to understand the risks and be comfortable with them, and it sounds like you are uncomfortable. I like the suggestion @Jim Robertson made- maybe there is a middle ground here. Finally- how many bids did you get? I don't know anything about flat roofs, but $30K sounds like a lot for a 5K sf space. That's $6 per foot for roll on roofing? I'd get a few more bids, just to make sure I had a good grasp on what that repair should cost. Best of luck!

@Corby Goade - We are only starting out with $30K cash, so finding two duplexes in our bloated market would be tough with that tight of cash, that's why we've been hunting for off-market/seller financed deals. We do have a pipeline with some other leads, it's just a slower start than we anticipated with this deal. Obviously, when things look too good to be true, there's usually a reason for it.

With regards to the number of bids - I called about a dozen companies. My market has very few roofers that will even touch a flat/commercial roof, and every contractor that called me back I had up there. In total, I had 5 bids, ranging from $30k for repair to $70k to reconstruct. One guy said he'd throw some tar up and try to patch a few holes for $4-5k, but he said he didn't recommend that because it's just a band-aid. 

1. Negotiate with the seller 2. if that doesn't work for you, chalk this deal up to your education/experience  3. remember as long as you keep looking, you will find other deals and  4. you are now better equipped to find the RIGHT deal for you, so don't be too impatient. 

Try to remember, this is all part of the process.

Good luck!

Thank you! As I've heard hundreds of times on this podcast and others, you earn your college education in this game through the work. 

I'm meeting with the seller to negotiate tonight, so I'll update this post if I've got any more info. Thanks for all the feedback, and any other negotiating strategies/suggestions would be appreciated. 

@Kevin Mosier   have you looked into companies that come and recoat/seal the roof?  There's a company that operates around our region called Five Star Commercial Roofing, that we have used many times on commercial buildings.  No affiliation with them, but their system seems to work well and it is always much cheaper than a roof replacement.  Not sure if they reach that far north, but I'm sure someone in your region can do a similar coating. 

Of course he doesn't think its a big deal. It would be your problem not his. This doesn't smell like a deal. 

@Kevin Mosier So you’re getting great advice. As folks like @Jay Hinrichs you now know why an owner would offer 0 money down, a 30 year amortization schedule, and an attractive interest rate. If you screw up and they take the property back they at least get a repaired or new roof out of the deal. Boom, there’s the “equity”.

What doesn’t make sense is why this is coming up just before closing. And, also, if you had the property inspected how did the inspector missed the water damage in the bathroom of the tenant?

Suffice it to say that if you’re seeing these issues during the diligence timeframe you’ll find out about more during your first 12 months of ownership. If you want to bump the rents, tenants move, at turnover who knows what else you’re going to discover.

Either way, I’d imagine that if you want to go forward...do a roof replacement. Then at least it’s done, over, out of the way. Right now it appears you want to fix deferred maintenance but...well...deferring a replacement with a temporary fix.

And if you can’t afford a replacement, well, you probably won’t be able to afford the other issues that come up pre-refinance.

Thanks @Andrew Johnson - your advice is appreciated. 

I believe the light fixture failed between the inspection and the following week when I had the roof guys out to look at it. It's that time of year in the Northland when the snow is melting and these problems start to come to light. 

@Jacob Brattain Thanks for the lead - I'll reach out to them and see if they make it this far north. We're almost to Canada, on the south shore of Lake Superior. Not sure their reach, but maybe they can point me in a direction... 

The bigger building sounds more exciting than acquiring the duplex but a lot of that hype is from people who are concerned about unit count.  Although it may be cool to talk unit count it really is cash flow that matters.  If a duplex affords less risk you may be better off in the long run.  

Agreed, @John Woodrich - cashflow is our primary driver, specifically, COC return so we can grow the portfolio and spread risk over units. We'd do a duplex right away if it cash flowed well enough, and that may be our fallback. The deals just don't compute as we'd like them to on most 2 units.

The other driver in the unit count is the valuation on the commercial/5+ units that we're attracted to. We can add value, fix up, raise rents and basically up the appraisal that way instead of relying on comps. I'd like to be in the 5+ range, but I might be learning with this deal that's not an option this early in the game. 

Originally posted by @Kevin Mosier :

Agreed, @John Woodrich - cashflow is our primary driver, specifically, COC return so we can grow the portfolio and spread risk over units. We'd do a duplex right away if it cash flowed well enough, and that may be our fallback. The deals just don't compute as we'd like them to on most 2 units.

The other driver in the unit count is the valuation on the commercial/5+ units that we're attracted to. We can add value, fix up, raise rents and basically up the appraisal that way instead of relying on comps. I'd like to be in the 5+ range, but I might be learning with this deal that's not an option this early in the game. 

Commercial is generally harder to cash flow due to interest rates and loan terms but if you can find a nice value add you should be in good shape.  The 4 plex I just got needed work in every unit, windows, etc and we have completed minor renovations in 2 of the 4 units and pushed to market rents.  2 units to go, will take care of the windows and a couple other things in the summer and try to push the market a bit when renting with rent increases after the tenants can see why.

The title sure is a lot better than “Disappointment right AFTER closing”

I agree with @Corby Goade If you're not comfortable then pass or offer a deal that would make you comfortable if he passes step back and keep an eye on the place. If it doesn't move you may be able to return later or he may come back to you and accept your offer. Having now bought two properties using owner financing I also agree that if they are saying no money down there is likely a reason. I passed on at least 6 owner finances before I bought my last one. If it's a decent property they usually want some cash up front. In both cases I ended up paying a larger deposit then the owner was asking for to get my price and/or terms. I have one I'm watching he rejected my offer which was about 25% below asking and half the deposit because of repair needs he thinks don't need to be done. Well it's 6mo later and he's still sitting on it. I will wait a couple of more months and let him know my offer still stands and see what happens then.

Thanks @Todd Radus for the advice. I'm headed to meet the seller in about half an hour, we'll see how it goes. 

What else has he just done the quick & easy fixes on? Property sounds like a ticking time bomb to me.

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