As this is my first blog post on the BiggerPockets Blog, I thought I would take a couple sentences to introduce myself before I jump into my topic of the day…
My wife and I are business partners, investing in real estate passively for several years, but we have only just started to “get our hands dirty” these past 18 months or so. We currently run a business rehabbing and flipping houses; while we don’t have long-term real estate or construction experience above and beyond that 18 months, we do have some serious business experience. We have both spent most of our careers in management for Fortune 100 companies – managing large teams, large budgets and some wildly successful products.
Coming into this industry, our lack of hands-on real estate and construction experience forced us to focus on the business aspects of real estate in order to maintain our success. While we’re quickly learning the construction side of things, our strong focus on optimizing our business practices has given us a somewhat different perspective on real estate investing than most people have. My hope is that I can use some of our business experiences – both past and present – to help provide other investors with more of a “business perspective” on investing.
With that in mind, I’ll jump into today’s blog post topic:
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Controlling Your Deals
My First Catastrophe
Our trial-by-fire in this industry came the second time we got one of our houses under contract to sell. My wife had just gotten her real estate license, and this was the first time she was representing our company in a transaction. Everything was going smoothly until about a week before the closing, when we called the buyer’s mortgage broker to ask a question, and he never called us back. A couple days went by, and we tried again. Still, no response. We called the buyer’s agent and he informed us that he was having trouble getting in touch with the broker as well.
This went on until a day before the closing, when the truth finally came out – the buyers were friends with their mortgage broker, and because of a couple issues on their credit, the broker was unable to get the deal through underwriting. The broker was avoiding us, hoping to get the issue resolved before he had to explain to us what was going on. Apparently, both the buyers and the broker knew about the credit concerns from the beginning, but had assumed (or at least hoped) that everything would be cleared up by the time we were ready to close.
Needless to say, the deal never closed, and while we collected the small earnest money deposit from the buyers, it didn’t make up for the 6 weeks the house was off the market or the frustration we had to endure.
It’s Not My Fault. Or is it?
Clearly, we were rightfully pissed at the buyers and the mortgage broker who lied to us. In fact, who knows, perhaps the buyer’s agent was in on it too! We made a point to tell our story to everyone who would listen, appreciating all the reassurance we got, that this wasn’t our fault and that there was nothing we could have done to have avoided the deceit.
The following week, I was having lunch with a big-name investor in my area who had been mentoring me and who was helping me navigate the industry. I told him my sob story, but instead of commiserating with me and reassuring me, he said the following: “Yeah, you screwed up on that one…”
Huh? Our fault? We were lied to. How could this possibly be our fault?!?!
I then got what seemed like a 2-hour lecture about all the things we did wrong on this deal. And that 2-hour lecture boiled down to one basic tenet that we have since embraced, and that all investors should seriously think about:
It is my responsibility to control my deals. If something – ANYTHING – goes wrong, it’s my fault
This simple concept has completely changed our perspective on investing. While we’ve continued to have our share of frustrations, we have never again felt like victims, and we have always felt a much greater sense of control over every deal we do.
CONTROLLING THE UNCONTROLLABLE
I imagine at this point, you’re thinking to yourself, “Why should I take responsibility for other people’s incompetence?” and more importantly, “How the heck can I control other people’s actions?”
Let’s start with the first question.
The sole reason why you should want to take responsibility for other people’s idiocy is that, in the end, more of your deals will close successfully. This means more money in your pocket, and ultimately, more success for your business. If that’s not motivation enough, to be willing to take responsibility, I’m not sure I have the ability to convince you.
As for how you can control other people and situations that are seemingly out of your control, that all boils down to foreshadowing and preparation. Take my example above – how could I have avoided the situation where the mortgage broker and the buyers were lying to me about their ability to qualify for their loan?
In retrospect, here are just a few of the things I could have done to mitigate the risk and potentially have avoided the problem completely:
- I could have required the buyers to use a mortgage broker who I had a relationship with and who I knew I could trust;
- If the buyers didn’t want to switch brokers, I still could have had them pre-qualify with my broker to verify their situation;
- If the buyers didn’t want to call my broker – or if I didn’t have a broker that I worked with – I could have asked the mortgage broker for a copy of the buyer’s credit file to verify their financial situation myself;
- I could have required the closing period be shortened from 6 weeks to 3-4 weeks, thereby reducing my time-off-market if an issue arose;
- I could have required a larger earnest money deposit, thereby ensuring that we were better compensated, should this type of issue occur.
If I thought about it some more, I could probably think of another half-dozen potential requirements I could have imposed on the buyers to have avoided (or compensated me for) the unsuccessful transaction. Of course, you could argue that the buyers could have refused to cooperate with any of these terms; in that case, it would have been fairly clear to me that the buyers were hiding something, and I could have comfortable rejected the offer and have moved on.
Preempt and Avoid
Over the course of the past 18 months, 16 rehabbed houses, and probably two dozen contracts with buyers, we’ve started to see the early signs of problematic deals. These included small things –- like buyers asking for long closing periods or high closing cost contributions –- that are too-often indicative of marginal credit or other financial issues, and larger things –- like unresponsive mortgage brokers, paperwork that can’t seem to get signed and wishy-washy buyers –- that just scream “Don’t do this deal!”.
In these past 18 months, we have slowly started to evolve a set of standard requirements that we impose on all buyers when they make an offer. While these requirements won’t allow us to avoid every possible issue, it does allow us to preempt and/or avoid the most common pitfalls that we tend to face with our buyers and our selling transactions.
Here are the basic ground-rules we live by when it comes to negotiating offers from our buyers…these are presented to the buyer in the form of a counter-offer when they submit a contract:
- If the buyer requests that we pay any portion of their closing costs, we require that our closing attorney is used to close the transaction. Because we have a close relationship with our closing attorney, we don’t have to worry any last-minute surprises, title problems or closing issues;
- While we would never require a buyer to use our preferred mortgage broker, we highly encourage it. If the buyer chooses to use our broker, we will accept a much lower earnest money deposit (1% instead of 2% of the purchase price) and we will pay for the appraisal (saving the buyer up to $450). When the buyer uses our broker, we will know upfront the buyer’s financial situation and the likelihood of a smooth transaction;
- If the buyer chooses not to use our broker, we require at least 2% of the purchase price be submitted as an earnest money deposit. When the buyer doesn’t use our broker, we incur some risk, but it’s offset by the large deposit we’ll keep if the deal doesn’t close;
- We require that the closing date be no more than three weeks from the time the contract is signed. While many buyers will tell us that their broker can’t accommodate that quick of a closing, we inform them that our broker can, and that they should highly consider switching brokers;
- We provide no more than 7 days due diligence period, 14 days for financing contingency, and 14 days for appraisal contingency. These are very reasonable time frames for the buyer, but also requires everyone to keep the process moving along;
As I mentioned earlier, my wife has her real estate license. This gives us the ability to stay on top of all aspects of the deal – from coordinating with the closing attorney, keeping on top of the mortgage broker, managing the appraisal (a whole separate topic), etc. Not only do we encourage the agent on the other side of the transaction not to “interfere” in the oversight of the process, we actually offer them a bonus if they will stay out of the way (we don’t use those the term “stay out of the way,” but we make it clear that we’ll drive the process and if it closes on time, they’ll get a $500-$1,000 bonus).
There are a million little issues that can come up in a deal, and you can’t avoid every single one of them. But, if you try to predict them before they happen, and if you take responsibility for each issue as it arises, you can do whatever it takes to avoid the issue or to make sure that it never happens again.
In fact, I’d be willing to bet that the more often you take responsibility and say, “That’s my fault!” (even when you might not think it is), the more smoothly your deals are likely to go.