Thankful I Passed on this Great Deal

2 Replies

I recently cancelled escrow because based upon my due diligence I would not have been able to exercise the strategic investment model I was seeking to do.  Our goal: buy, turn into a legal duplex, hold for cash flow with potential to knock down and build apartments/condos in the future.  However, canceling escrow on this recent deal may have been the best thing I have done thus far in real estate.  Here's why ...

FACTS:

4/2 SFR in front with a permitted 2/1 "rec room" in the back. Price: $520k. Rent potential: $5,500/mo ($3,500 for front house and $2,000/mo for back unit). Located in North Hollywood Art District (Los Angeles) - a place I love to buy - so if anyone has any NoHo properties for sale - please PM me :) 

ANALYSIS:

We cancelled escrow because of several factors: 

The back rec room was not yet a lawful unit that one could legally live in. Our goal was to make it one and thus add value by converting it into a legal duplex.  Doing so would allow us to bring in roughly $2,000/mo in rent for that back unit - thus increasing the value of the asset and pleasing our investors.  However, we would have needed to get a variance (an additional $35k - which we budgeted for).  Another issue arose however, the back rec room was too close to the side neighbors yard - which again could have easily been resolved via a variance.  We were confident after speaking with the city on several occasions that we would be able to obtain a variance.  But if for some reason we couldn't get a variance, we were looking at being forced to knock down the structure or move it several feet away from the property line.  Either, very costly.

There was the issue of parking.  We needed 3 spots (2 for the house in front and 1 for the back unit).  There was a long driveway which would have accommodated 3 cars, however, they had to have all been tandem.  In Los Angeles, you cannot tandem park more than 2 cars for purposes of putting in parking.  

Now, I could have decided to buy the property with the SFR and the back unit as a rec room and simply rent it out to one large multi-generational family - and that would have been certainly legal. Only one lease - for one unit to rent. However, $5,500 is a lot of money for rent each month, even for a "compound" like we could have offered here to the right ground of tenants. However, the potential tenant pool is cut so drastically as a result of this price as well as finding the right tenant that wsa ready, willing and able to move into this sort of living situation.

One colleague asked me why I wouldn't "just rent out the rec room illegally so I have the duplex - the "City would never find out - after all, there is a shortage of housing in the area."  While I appreciated the perspective and the question, as I explained to him - I am not in a position nor desire to put my investor's financial investment in such blatant risk.  I have a fiduciary duty to my investors and a reputation to uphold.  If we did get caught we would have to pay all the back rent and violation fines that it was not worth it.  My investors could have certainly sued me and my company had I did the deal knowing all of this.  

CONCLUSION:

While I was completely bummed about canceling the deal, I'm glad we didn't do the deal.  I'm reminded by a mentor of mine - who said "I've never lost sleep on a deal I didn't do."  Patrick - thank you for that.  So true. 

Originally posted by @Jared K. :

I recently cancelled escrow because based upon my due diligence I would not have been able to exercise the strategic investment model I was seeking to do.  Our goal: buy, turn into a legal duplex, hold for cash flow with potential to knock down and build apartments/condos in the future.  However, canceling escrow on this recent deal may have been the best thing I have done thus far in real estate.  Here's why ...

FACTS:

4/2 SFR in front with a permitted 2/1 "rec room" in the back. Price: $520k. Rent potential: $5,500/mo ($3,500 for front house and $2,000/mo for back unit). Located in North Hollywood Art District (Los Angeles) - a place I love to buy - so if anyone has any NoHo properties for sale - please PM me :) 

ANALYSIS:

We cancelled escrow because of several factors: 

The back rec room was not yet a lawful unit that one could legally live in. Our goal was to make it one and thus add value by converting it into a legal duplex.  Doing so would allow us to bring in roughly $2,000/mo in rent for that back unit - thus increasing the value of the asset and pleasing our investors.  However, we would have needed to get a variance (an additional $35k - which we budgeted for).  Another issue arose however, the back rec room was too close to the side neighbors yard - which again could have easily been resolved via a variance.  We were confident after speaking with the city on several occasions that we would be able to obtain a variance.  But if for some reason we couldn't get a variance, we were looking at being forced to knock down the structure or move it several feet away from the property line.  Either, very costly.

There was the issue of parking.  We needed 3 spots (2 for the house in front and 1 for the back unit).  There was a long driveway which would have accommodated 3 cars, however, they had to have all been tandem.  In Los Angeles, you cannot tandem park more than 2 cars for purposes of putting in parking.  

Now, I could have decided to buy the property with the SFR and the back unit as a rec room and simply rent it out to one large multi-generational family - and that would have been certainly legal. Only one lease - for one unit to rent. However, $5,500 is a lot of money for rent each month, even for a "compound" like we could have offered here to the right ground of tenants. However, the potential tenant pool is cut so drastically as a result of this price as well as finding the right tenant that wsa ready, willing and able to move into this sort of living situation.

One colleague asked me why I wouldn't "just rent out the rec room illegally so I have the duplex - the "City would never find out - after all, there is a shortage of housing in the area."  While I appreciated the perspective and the question, as I explained to him - I am not in a position nor desire to put my investor's financial investment in such blatant risk.  I have a fiduciary duty to my investors and a reputation to uphold.  If we did get caught we would have to pay all the back rent and violation fines that it was not worth it.  My investors could have certainly sued me and my company had I did the deal knowing all of this.  

CONCLUSION:

While I was completely bummed about canceling the deal, I'm glad we didn't do the deal.  I'm reminded by a mentor of mine - who said "I've never lost sleep on a deal I didn't do."  Patrick - thank you for that.  So true. 

 Very informative and interesting analysis. 

Thanks!

I tell my fellow REI (last night's presentation as an example) that "sometimes the best deal you make, is the one you don't make".