Let’s Talk About Harsh Reality For a Minute
There are so many great articles about how to be successful here on BiggerPockets, and all the gurus say it’s easy to make millions! I am a very positive thinker, but I also like to know about the harsh realities of anything in life. If there is a tremendous upside, there is always a risk that must be taken. If there was no risk, it would be “too good to be true,” and everybody would be doing it! It is the risk-taking, and our individual risk tolerance, that sets us apart from each other in business. What if that risk does not work out in your favor? What is the reality of that, and what do you do? If you invest in RE long enough, eventually you will make a misstep that costs you money.
When that happens, what do you do?
How to Analyze a Real Estate Deal
Deal analysis is one of the best ways to learn real estate investing and it comes down to fundamental comfort in estimating expenses, rents, and cash flow. This guide will give you the knowledge you need to begin analyzing properties with confidence.
We Couldn’t Fail, or Could We?
In 2009, we had been investing for about a year. We had 3 successful deals under our belt -the first netted us around $17K, the next was $33K, and the next about $70K. Wow, we were on a roll, or so we thought. An agent presented a property to us in an unfamiliar area that was about an hour away. It was in a great neighborhood consisting of newer houses less than 20 years old but, to be blunt, the owner of this home was a slob. Dirt and crap from one side of the house to the other.
She was a hoarder in a nice neighborhood.
The agent told us we could buy, clean out, do minimal work, and get out for a clean $25K profit. Sounds good right? After all, it was going to be an easy, quick flip! HA! BTW, when someone tell you they have a simple, quick flip, tread cautiously!
We had many contractor problems as we did not have proper systems in place, and being so far away it was tough to manage. However, at the end of the day, we did get the job done. We were behind schedule, but it was ready for sale. Day 1 on the market, full price offer….BAM! Our projected profit was now close to $38K!! Well, we’re cookin’ with Crisco now, everything is just falling into place …. and then the neighbor makes an appearance!
You’ve Gotta Love Those Negative, Nosy, Know it All Neighbors!
The next day our buyer was walking in the neighborhood admiring her new purchase and getting ready for closing when the nosy neighbor came out and wanted to let her know how bad the water in the well was. Mind you, OUR water was tested and was 100% fine. It was hers that was no good, they were two totally different wells! I have no idea what else was said by this PITA neighbor but the buyer promptly backed out, thinking we were hiding something. The house now sat on the market for the next 5 months, showing after showing, no interest. I wonder if the neighbor was at each showing to let them know how bad her lot in life was? I never understand that. Why would a person devalue their own property by making the one right next door sell for less? It only hurts the value of their own home!! I suppose we’ll just say she wasn’t the brightest light on the block 😉
After dropping the price numerous times, we finally receive an offer, it was for about $25K less than the first offer. If you read my last post on the silent killer of real estate deals, you will remember that holding costs can eat you alive like an african skin eating virus! Well think about it, we have now accepted an offer $25K less than expected 5 months later than expected, can you say…loss????????? Well it sure was. By the time it closed we had to find over $5000.00 to bring to the table just to get us out of the deal, mostly it was to pay off the investor. Our investor on that deal made more than we did, heck, the lawn guy made more than we did!
What Did We Learn?
1 – If you have a negative neighbor who tries to kill the deal, bury them in the same well they are complaining about. Wait, was that my outside voice? Sorry! Oops, what I meant was, go out of your way to be nice, introduce yourself to such neighbors and explain how it really helps their values when a new house is sold in their neighborhood. (Then let them out of the well) 🙂 If you suspect a problem neighbor, have an open house for the neighbors and let them know your intentions. Offer referral bonuses if they have a buyer they refer to you. Send brownies to soften them up a bit, and if it’s out of control, be present at all the showings to run interference if need be.
2 – Count ALL of your costs each day. The longer you hold out for a higher price, the more you are going in the hole. It is a risk/reward situation, so be very careful as you make decisions about price drops and negotiating offers. Remember, the market does not care one bit what you HAVE to get to break even. The market will only pay what the house is worth, period. Don’t kid yourself about the true value. Let the market tell you what it is going to sell for. I love to hear people say, well if it costs more money, you are just going to have to ask more for the house to cover your losses! My annoyed response is usually, “Okay, lets come back from La La Land for a minute. I do not determine a price, the market does! So get back in the well!…..Outside voice again? Oops!
3 – Once you realize you are losing money, GET OUT FAST!! If you were wounded and hemorrhaging blood, you would need to stop the bleeding in order to survive. Be honest with yourself. If you are in a bad deal, it is only going to get worse. Are any of you “Cheers” fans? It was a great show in the 80’s and early 90’s. Sam Malone had a theory in life, “Ignore the problem, it will go away”. With investing, nothing could be farther from the truth, most people ignore the daily losses happening, while hoping for a miracle. Make no mistake, whether you ignore them or not, they ARE accruing and happening right in front of you, so be honest with yourself and make sound, non emotional business decisions to minimize the damage. Once you have started to lose money, the only question is, how much do you want to lose? No white knight with a bag of cash is going to come in to save you. You ARE that knight! So be a smart, strategic knight, and get out as unscathed as possible. Remember the movie, 127 Hours, based on the true story of Aron Ralston? He was trapped by a large boulder and decided to cut off his own arm, with a dull knife, in order to survive. What an awesome movie. We must do the same thing when we are losing. We must make the tough decisions, or the world will make them for us!
4 – ALWAYS pay your investors, contractors, and suppliers. One of the main reasons we lost money on that deal in the end was because we had to pay a lot of interest to our investor. We had no problem whatsoever with doing that because we saw the big picture. When it was over, he asked how we did on the deal. When we told him what happened, he was impressed that we held up our end of the deal, even though it hurt. Do you want to have a great reputation? Do what you say you are going to do … ALWAYS. People will invest with you and know that no matter what happens, they will get paid. It is a sound principal that we have built our company on, and my advice is to do the same as it helps our entire industry. If you are in a bad crunch and need cash to close the deal but don’t have it, talk to your investor, ask them to let you get out of the deal and write a note outside the mortgage. That way at least you can close on the house and stop all of the other accruing costs. Then immediately do whatever is needed to fully pay the investor off with their interest. I would go flip burgers if I had to in order to keep my reputation, it is totally worth it.
5 – Consider any money lost as tuition. People go to school for years and spend $100,000+ only to never really use their degree. Was it a loss? Of course not, they learned many valuable lessons along the way. The school of hard knocks has it’s own tuition. Sometimes it’s time, stress, health, or money. If you lose money on a deal, DON’T LOSE THE LESSON! We learn so much from our failures, if we embrace them we will come out much stronger. Remember, we are human, we WILL make mistakes. I think the hardest lessons learned are the best lessons learned and will not soon be forgotten.
6 – Never listen to anyone who says, “Hey I have a really quick flip for you!” Don’t run for the hills necessarily, but do your homework well, especially on those.
My hope is not that you get discouraged from investing at all by my stories. My wish is for you to be armed with the realities of what can happen if you do not make sound decisions. If you do your homework you greatly minimize your risks. In a world of self proclaimed guru’s claiming fortunes (if you give them yours,) I like to be a voice of reason – I am very open about our failures, so that people may learn from them and not repeat the same lessons. Do your own homework, be totally honest with yourself, seek advice, but in the end make your own decision. Go confidently in the direction of your dreams, and bold and mighty forces will come to your aid.
Have a great week!
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