$196 Million Chapter 11 Bankruptcy Story

[Johnson H.]

I see a lot of new investors on BP and I wanted to share this story of a very prominent investor, hard money lender, developer, well known in the community that filed for bankruptcy during the financial crisis. He was very successful until the music stopped. 

http://www.northbaybiz.com/General_Articles/General_Articles/When_the_Music_Stopped.php

I know that real estate investing is exciting and can make people a lot of money in a short amount of time which is why so many new investors are coming out to the site. However, people should be aware that anybody can lose money, even someone as successful as this investor. Everyone should be careful with whom their dealing with and the leverage they are employing. The real estate market operates in cycles, don't get stuck during the next downturn without the proper risk migrants such as excess cash flows, reserves and other streams of income. Finally, think twice about that next cash out refi, it might not be the most prudent thing to do.  

[Mike H.]

There were a lot of people that lost everything in that downturn. It was one of the worst busts we've had in about 25 years or so.

The real issue with most of the people that went bust is that their model only had one real exit strategy - selling and/or appreciation.

Their numbers didn't work based on buy and hold investing and when the market for selling real estate plunged, there was no way for them to stay afloat.

Most of the people that I knew that took a bath were basically all in on some property/properties. The smaller ones had a couple of spec homes they had built or were in the process of building. The next level up were guys that were invested in a subdivision and so on.

But none of them had the option of an exit strategy of "we'll rent this stuff out" until the market returns.

And to me thats really all an investor needs to provide a fail safe so that they don't lose it all.

To me its simple math. If your properties are cash flowing at a good enough clip, then you're chances of busting are significantly reduced. I would never say never as there is no such thing as absolute guarantees when you're dealing with any business. But I think the old timers that had solid rentals actually made out pretty well during the bust.

Their occupancy went up. Their rents went up. And they were able to buy (or "steal" as I like to think of it) quite a few more houses during this bust period.   And now they're really sitting pretty.

Whats their risk? Their risk is that banks loosen their lending guidelines again and their renters can all start qualifying to buy homes again.  But if that happens and their occupancy drops again, then that will also mean that the price of their homes will shoot way up again just like it did before.

At the end of the day,  there isn't much difference in having 30% equity or 50% if you don't have adequate cash flow.   Its the cash flow that allows you to sit on houses as the prices plummet. Much like stock, you're not actually going to lose any money if you never sell.  

But if you have no cash flow, then you have a problem when the downturn comes.
Those people couldn't afford to hold those properties and they couldn't sell them either.

Thats how you bust out.