First deal might fall through bcs. of bad contract

18 Replies

Hi folks,

This is a bit of a new member introduction and request for feedback on my first deal at the same time. I'm currently a grad student living in SoCal, and my wife and I have decided to start building a real estate portfolio. I've spent about a year listening to the podcasts (over a hundred) on my commute to campus, and reading investing books including Brandon Turner's and David Greene's. I decided to look for my first deal in my hometown in central Arkansas, basically using Greene's book as an instruction manual. I haven't posted much since I figure my inexperience contributes little that isn't already well-known, but man I could use some feedback on this situation.

I found an 8 unit property, two 4-plexes on a lot, 2b/1ba each, very new, renting toward the top of the rent range for the area ($700/mo). I found an agent who has been diligent and responsive with my questions, and quick to put in my low-ball offer.

The offer is contingent upon breaking it up into separate residential loans on each 4-plex (for the 30 year am).

Then I started thinking: you know, there's nothing in this real estate contract that says I have an out if it turns out the financials aren't as rosy as advertised. Big oops. Fortunately the seller countered, and I haven't accepted yet, so I'm not stuck. The numbers still work so I want to accept the counter-offer with an addendum specifying that I'm buying the property on the condition that current rents are as advertised, subject to verification, etc. etc. However, here's the problem. My agent doesn't want to add any such verbiage. I am confused.

The main protests he raises are things like (paraphrased):

  • "The seller advertised 700/mo on the MLS, so if it turns out he misrepresented, that would be a breach of contract." (The problem is nothing in the contract talks about rent at all, so I don't see how it could be breached thereby).
  • "It's understood that you're buying these for investments, so it's assumed the sale is conditioned on verifying current rents." (The problem is, since we're doing residential financing, the contract is worded like a residential deal, again, nothing about rents, so I'm not at all convinced a judge would "understand" that this is for investment purposes).
  • "It's a little presumptuous to ask for private tenant information and financial data before even having a signed contract." (Maybe we're just talking past each other? I don't want it before the signed contract; I want it in the signed contract--I want to sign it!! I'll sign a NDA too!)
  • "I've never had anyone ask for this at this stage in the process." (?!?!? I mean, OK, it's a small town in the South, so I could see things running along more of a good ol' boy system rather than meticulous contracts, but still!)

OK, so what the heck is going on? I get that he doesn't want the deal to tank because then he doesn't get paid, but I don't even see how this could possibly tank the deal. It's like buying a business without seeing proof of any sales. Wouldn't a seller want to share financials as a selling point if they're that great? If there's anything I've learned from BP, it's "for the love of God, always verify the financials." Or did I misunderstand how the process is supposed to work? <---not being sarcastic.

The main challenge seems to be getting on the same page with my agent. I just can't understand what he's worried about. For all we know at this point, the seller might be happy to provide details. So I guess my concrete questions are:

  1. How do you get an otherwise diligent agent to do what you want when apparently it's something he's not in the practice of doing?
  2. What is the bare minimum proof of rent I should require if/when I actually get my way?

I will be very grateful for any feedback the BP community can provide. If this isn't going to work out I need to move on because I'm ready for a deal dangit!

It shouldn’t be out of the norm if you ask for rent rolls or P&L for the units. I typically also ask for time left on each lease and a sample of the lease that’s used. That’s not saying you’ll get them, but 9 times out of 10 you will. Lastly, you can always back out of a contract... while it’s not advised for the sake of your reputation, you’re never forced to buy a property. Your real estate agent should be more than willing to put contingencies in the contract, no matter how odd they sound.

Yeah, your agent is off based. Nothing in the MLS listing gets "implied in the contract" and there are no "assuming rights not contained in the contract".

I would put in the contract, along with the typical inspection clause, a due diligence clause for say 10 days or so, that begins After copies of leases are deliverd.  I'd also get estoppels from the tenants should you get that far.

More importantly, if these two 4 plexes are on One parcel, one tax ID no.,(different lot no.s make no difference) you can Not possibly get two residential 1-4 unit loans, period.....unless the seller is willing, and able as per local zoning reg.s, set backs, etc., to subdivide the parcel into 2 parcels, which would be unlikely.   If they are separate, you'd be good to go, 25% down of course unless you are going to live in one of them.

@Dustin Davis , thank you. Sounds like I'm not being super unreasonable. Is there particular verbiage you use to make the contract contingent upon your "approval" of the lease, rent roll, etc.? Do you think it's bad for reputation to back out of the deal if a contingency is not met, or just if you back out for no good reason?

@Wayne Brooks , do you just make the due diligence clause based on "buyer's sole opinion" of what's good enough? I'm having trouble figuring out how to indicate that I'm serious about this deal and not going to nitpick every little discrepancy; I just want to see proof of income, as with any business. Regarding the one parcel, my lender seems to think it will not be a problem to divide it, something she's done before. I guess I'll make sure we confirm that it's possible before spending a bunch of money on inspections/appraisals. Thanks for bringing that up.

There should be an Tenant Occupied Addendum check marked on your contract. Then attach that addendum as part of your offer. Here in Pennsylvania that is right on the PAR contract, this then gives the seller 5 days to get you copies of the leases after you have an agreed upon contract to verify the terms of leases. The other expenses should be disclosed ahead of time, but this is a way to keep tenants personal info private until after they know the deal is solid, but gives you a way out if there is a misrepresentation on rents.

@Joseph Taub contingencies are put in the contract to allow you to back out, for good reason. 

Backing out for no reason is what gets you a bad rep... Example being one we just went through, an investor from out of state tied up our 3 acres along with 10 other properties in our area for almost a month, flew in and broke contract on 8 of them. Ours was one he broke contract on. He wanted his pick of premium properties and ended up burning a month of prime buying season for us. His name and rep in my book are junk... Don't be that guy. 

Well, there is one simple fact learned here ... you should never use this agent again for buying an investment property ... and if this deal falls through, find another agent before moving forward.

@Wayne Brooks has supplied some good info here that you should pay closer attention to.

Splitting a parcel has many more nuances than just drawing a line in the middle of it on the map. I will list a few.

Sewage management. If septic, does each building have its own septic system or is there just a single septic system? If public sewer, does each building have its separate sewer tap into the public system, or is there just a single tap? How about storm water detention basins - does each have its own?

Parking. Does each building have its own parking area, or is there just one big parking lot? Does each building have the needed road frontage?

Setbacks. Once you have established the line down the middle so to speak, are all setbacks going to be met?

Just a few of many nuances to consider if you think dividing a parcel in two is simple.

Thank you all for your feedback.

@Wayne Brooks , I don't know that she implied that she's been the one to do it when we spoke. That's probably just me not knowing how to talk about it correctly. She's seen it done at least, so it seems. As you say, if the seller is willing--hope I didn't sound flippant about your advice. If I do end up getting this deal done I'll come back and let you know what procedure we follow.

@Steve Babiak , thanks for bringing up those items. I had not considered all of those specifically, though I did expect there would likely be complications. My mindset was, if I try to answer every question up front I may never get started. Getting two residential loans would require splitting the parcel so if we couldn't do it then I'm of the understanding my financing contingency would apply. From what I understand, the seller is the original owner who built the buildings or had them built, so he should know a lot about the way they're set up. Sounds like next steps are to find out about these items and whether it's likely to even be possible. Thank you.

Remind your agent that specifically at the bottom of the MLS listing is a disclaimer about ‘information is not guaranteed’ blah blah blah.

Presuming you have an inspection clause, you can always use that to get out if leases don’t match etc. but you’ll have to be prudent and be sure you get them within the contingency period.

@Joseph Taub

BTW, it take about 5 minutes to look the property up on the local property appraiser site to see if it is one property, or two......or the the tax id no/legal in the listing may tell you.  Seems like a lot of wasted time speculating and waiting to find out.  An inquiry to the seller up front seems to make the most sense, if it needs to be divided.

@Wayne Brooks , I would have thought so too. I tried all of those approaches yesterday. So far, I can't figure out the county site. Maybe they can help me over the phone on Monday. I relayed questions to the seller about these items, and didn't really get complete answers back...including no clarity on the tax ID. The listing says they were built in 2016, but the listing agent is saying that since they are new they don't have tax records yet...is this normal?

@Mike McCarthy , thanks for pointing that out. I did see that clause as well the last time I read it over, so I will be pointing it out if it comes up again.

My agent was at least able to convey to the seller that I will want to see leases and proof of income history (as will the lender). They're willing to share leases with names and personal info blacked out, but profit and loss is lumped together with all the seller's other properties and they can't break it out. I assume this just means it would be a major hassle to break it out, not literally impossible? 

It's worth pointing out that my agent is also a pretty successful investor, which is why I wanted to work with him, and doesn't seem to be bothered by any of  this. He seems to think more along the lines of "if the inherited tenants stop paying, just evict them." But my thinking is, the property is advertised with very high rent for the area, so I want to see proof that it has actually been getting it. If rent were much lower, the deal isn't nearly as attractive.

Another question: is it normal for communication between buyer and seller to be this difficult? It seems like what I want to know, or what I'm offering to do on my end, keeps getting lost in the shuffle. 

@Joseph Taub

As @Steve Babiak said, the kind of "splitting" you are seeking can end up becoming rather complicated. I assume you are doing this to take advantage of Fannie/Freddie loans. Just note that you might not get a firm answer by the time you do the closing. 

As for this agent, it doesn't seem like it's the right agent for you. Just because someone is a successful investor does not mean that he will be a good agent for you. I must say that I do kind of think the way he does when it comes to existing tenants (i.e. I don't really care what the current tenants are paying). But that's up to you. 

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

Originally posted by @Joseph Taub :

@Wayne Brooks , ...

@Mike McCarthy , ...

Another question: is it normal for communication between buyer and seller to be this difficult? It seems like what I want to know, or what I'm offering to do on my end, keeps getting lost in the shuffle. 

Well, there are two agents in the middle of each communication, and it only takes one of them ignoring something for that something to get lost ...

Joseph - 

The stuff your real estate agent said in your original post doesn't make a lot of sense (it's implied in the contract?! Nothing is implied in a contract).  I'd recommend finding a local attorney to draft a new contract or a simple addendum to the current contract that is out there to satisfy your reasonable concerns.  

Thanks @Paul Younger , at this point I'm basically looking to make some kind of addendum. Since the seller hasn't differentiated this property's income from his other properties, and hasn't kept a detailed rent roll, I've asked to see copies of all current and previous leases to try to reconstruct some kind of occupancy timeline. Then I've also asked to have tenants sign an estoppel document before closing. If the seller is amenable to this, I'll put some verbiage about it in the contract.

Looking at what other apartments of similar quality in the area are charging and Cabot's overall rental occupancy rate, I think it's reasonable to expect this property to rent well. So my thought is I mainly need to make sure there aren't unacceptable terms in the current leases.

On the other hand, I've now found out that tenants don't pay water, so I'll have to find out if they're even set up to be metered separately, or if they can be sub-metered. The deal's income won't support paying water bills.

If the seller did not separate out from other properties it can be very hard to look at the actual numbers and verify.

I do not like top of the market rents when buying. If  a cycle shift happens then your property tends to be the first to fall as tenants look for cheaper alternatives.

Some of my friends own hundreds of units. They stay in the mid rent range of the market. In this way they can push rent growth each year and have a waiting list of tenants to fill any vacancies. The tenants tend to not fight rental increases as they know there are many others waiting to take their unit and they have a good deal in the market. The landlord also has to make minimal repairs as tenants do not want to (rock the boat) as top end properties they would be paying much more rent.

If you cannot highly and accurately validate the numbers with a property then you have to underwrite for the WORST case possible. The seller usually says (trust me) and other things to explain away their poor record keeping but you can't go off of that.

  

Originally posted by @Joel Owens :

If you cannot highly and accurately validate the numbers with a property then you have to underwrite for the WORST case possible. The seller usually says (trust me) and other things to explain away their poor record keeping but you can't go off of that.

  

 Thanks Joel, this was kind of what I was thinking. And when I underwrote the deal with "worst outcome" assumptions, it quickly became a not so great deal at the seller's asking price. 

Thanks also to everyone else who contributed, if I didn't tag you--I still considered your advice :) I've decided to walk away from this one. Just too many question marks (and it seems like every time I got an answer from the seller, it just raised more questions). I'll be writing a follow-up post with some more questions that arose from this situation.