From "Buy & Hold" to "Buy & Burn" to ???

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This deal has evolved and I'll post updates here when relevant. I added a brief post about this on my profile, but here are the rest of the details:

This is my second deal. My first was a vacant office building that I bought, renovated, and filled with four tenants (including my accounting practice). It's a great investment, so I told a realtor friend that I'm interested in multi-family and asked him to send me regular emails of listings in my area.

After a couple months I called him to say, "I'm going to stay in my lane and stick with commercial." To which he replied, "No problem. I just got a call from a bank today looking to have me unload a property for them. It's a house on 1 acre, 5 miles away from you. And they're asking $18,000." I asked what's wrong with it. And he said, "For that price, does it even matter? The median home value here is north of $200,000."

This was February of 2018 and I decided to go look at it. I was 95% certain that I would buy it, renovate it, rent it, and possibly refinance. But when we went to look at the property, this is what we found:

The front was a mess.

The back was even worse.

The inside was bizarre.

And the basement was frightening.

But it was so cheap! So I offered $12,000, they countered with $13,000, I accepted and on March 16th I wrote a check for this mess. In addition to the house being a disaster, there was a separate garage that was caving in, piles of trash in the yard, two old bread delivery trucks, a rusted out Ford Bronco, rotting building materials, and miscellaneous fishing gear strewn about the yard. What to do?!?

I knew after looking at the house that it couldn't be remodeled. So I decided to tear it down...or have the fire department burn it down? Currying favor with the town government seemed like a good idea, but I realized that there would still be rubble to haul away, all of the trash in the yard, and the foundation might be damaged by the fire. So I found a local contractor who was willing to tear it down. We went back and forth on price and I talked him down by reminding him of the value of the scrap metal that he could haul off and sell to a scrap metal dealer. I also knew that his work was limited because most side roads were posted (heavy vehicles not permitted due to frost heaves, etc.). In the end we agreed to $12,000 to tear the house down, haul everything away, and grade the yard. 

Once that was done I decided to look at putting a modular on the foundation and renting it out. Growing up my dad built ~75 modulars, so I was familiar with the concept and liked the plug-and-play idea. But a basic turn-key package was going to run me $175,000 - $185,000  in addition to what I had into it and the numbers didn't work at that price.

So now I have a nice 1 acre lot with a foundation, well, and electric for $25,000. 

Market value is in the $60k - $80k range. There is a .5 acre grassy area to the left of where I was standing when I took this picture. My sons and I are working on taming that and trimming some brush to improve the look and feel of the place. I would call it a lawn, but the grass had probably never been mowed and is very coarse. 

The new plan is to hold on to the property and look to do a 1031 exchange into a commercial building. Stay tuned for more developments!

Update #1: In April of this year a real estate investor friend/mentor let me know of a building near my office that wasn't on the market, but the owners wanted to sell. It's a large old house on a prime street in downtown. Six older couples purchased it 15 years ago for $455,000 and made more than $400,000 in upgrades to it. It contains a total of 12 offices with plenty of off-street parking. One of the owners was kind enough to show me the property and share the tax returns. Three years of tax returns showed an average NOI of ~$25,000. Typical cap rates in the area are around 8% which would result in a value of $312,500. They clearly had two problems: very low value and six older couples owning the property. I clearly had a great opportunity to do a 1031 into a great piece of real estate in an excellent location!

But I also had the challenge of needing to educate them on the value of their building. Just two months before I looked at it, two similar but larger properties on the same street sold for $802,000 and $1,322,222. To the owners of the property I was interested in, this meant that their building had to be worth at least $800,000. In fact, the NOI of the other two properties was in the listings and simple math showed an average cap rate of those two properties of 8.8%. This meant that their building might be worth less than $300k.

I scheduled a meeting with 5 of the owners to talk valuation. I had prepared a one page document with the relevant figures on their property and the other two recent sales. I explained how commercial property is valued and showed that the calculated value of their building was ~$284,000. I made it clear that I wasn't offering that, just showing them the math. Their spokesperson acknowledged that all of my figures were correct and the method of valuation is correct, but they couldn't sell it for that. When I asked what they needed to get, his response was that they need to be made whole and that they have $900,000 in to the building. I knew at that point that there was NO WAY that we could come to terms. That would be a 2.8% cap rate on a 100 year old building that needs new siding and windows. I explained that to make the numbers work, a buyer would need to double all of the rents. That didn't matter to them. I explained that no bank would finance the purchase of the building. That didn't matter either. I then encouraged them to talk with a commercial broker. One of the other owners actually said that they couldn't afford one! At this point I felt bad for them because it was clear that they have no idea what they are doing. I was prepared to offer them $400,000 based on pro forma figures that I had run, but there was no need to throw out a number that was that far off from theirs.

So we parted ways amicably. They are in a position where they have to sell to avoid estate issues with the 6 older couples that own the property. Perhaps they'll come back after a year or so to have another conversation.

More updates to come on the original property and what I will exchange it for.

Thanks, @Grant Rothenburger ! My next update will be about a 4000 sq.ft. office building. I've made two offers on it and hope to know more in the next day or two. It's vacant and is a bit of a long shot, but if it works out could be a great investment.

Originally posted by @Bob Langworthy :

Thanks, @Grant Rothenburger! My next update will be about a 4000 sq.ft. office building. I've made two offers on it and hope to know more in the next day or two. It's vacant and is a bit of a long shot, but if it works out could be a great investment.

 Looking forward to it!

@Joseph ODonovan , it definitely looked like it fell from the sky and I was a little nervous about what we might find inside or in the basement. Remarkably, there wasn't a single dead animal inside. But that's probably a testament to the basement containing a two car garage without any doors. Anything could have walked in and out of the place.

  • Update #2: I referenced a 4000 sq. ft. empty office building in a prior post. In the 1300+ days that it has been on the market, the price has dropped from $540k to $330K. In addition to the building, there's 12 acres of land that could possibly be developed. Not having the ability to write a check for it and realizing that the location is not ideal for many businesses, I decided to do have an initial conversation with a local hospital about their need for office space. I'm friends with the VP that just completed a $6,200,000 renovation and asked him about a need for space. They said that they were all set. Bummer! My plan to get an LOI from the hospital and then buy the property wasn't going to work!
  • Plan B: Make a very low offer. Maybe the seller just wanted to dump it at this point. I made a low offer and it was rejected. Not even a counter offer.
  • Plan C: Make an offer closer to asking price, but with a 90 day contingency to market the property and secure a tenant. The seller's reply was basically, "That won't work."

So at that point I decided to walk. Even though this property is a great value, it's not right for me. I've seen enough clients run headlong into trouble and heard enough stories here that I decided to be patient and wait for the right opportunity. Currently, I have an offer in on three residential buildings in a nearby town: 2 duplexes and a single family. I'll let you know more when there is more to know.

Quick update: we are going to hold on to this property through the winter and find a buyer in the Spring. We tamed the lawn and it looks pretty decent now. I'll post more as plans unfold.

Update: We decided to list the land for sale. The biggest reason is that we want to prime the pump and move towards our next cash flowing investment. We'll look to do a 1031 exchange from the land in to the next property. More to come!

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