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Why We Backed Out of a Recent Real Estate Deal

In March, Selenid and I went under contract on a new real estate deal. The property in question was a 3-plex in a C+ neighborhood within the path of progress. It met our criteria so we made an offer and the seller accepted. However, 2+ months later, we backed out of the deal.

So what happened?!

I think it is just as, if not more, important to talk this type of real estate investment deal as compared to the successful ones.

Like our recent post discussing the biggest lessons we learned from Property #3, our mistakes always teach us and make us better. In general and in real estate investing.

Although, in this case, it was less a mistake as it was staying true to our criteria and getting out when the deal stopped meeting our criteria. By doing this, I think we avoided a huge mistake!

Let’s set the stage for this particular real estate deal

As I mentioned above, this was a 3 unit property in a C+ neighborhood that was certainly within the path of progress.

Two of the units were currently occupied by tenants and renting well below market value for the area. One tenant had a lease lasting a few more months while the other was month-to-month. The third, larger unit was “recently renovated.”

The asking price was $230,000.

So, we went and walked through the property with our investor agents. The back unit, which had some updates but certainly was not a total renovation, seemed nice. It was a two story, 2-3 bedroom property.

The front units meanwhile were a disaster. First, the lower tenant would not let us in. The property manager (not the owner) who let us in the property then told us that the tenant was ~6 months behind rent. The top tenant let us in. And I have to say, this property was in the worst state that we had ever seen. Roaches, spider webs, broken things…real rough.

But, we did see some potential here…

Initial real estate deal analysis

real estate deal

You can see here that we estimated we could get the property for a bit below asking price at $222,500.

By our estimate, while there were a lot of repairs, they were largely cosmetic. We had out contractor look at pictures we took and he gave us a rough estimate of $30,000 which we increased to $40,000. This included some money for “cash for keys” with the upper tenant. That way we could get them out and rehab the unit.

We estimated rents a bit below market at $3,200 total (after repairs and renovations) for the 3 units.

The rest of the numbers are pretty standard for us, which you can review here.

With these estimates, our cash-on-cash return would be >15%. Thus, this met our criteria and we placed our offer.

Our offer

The owner was really upset not to receive asking price. But we were the only offer. he tenants scared others away. In this case, the owner did not realize the state of the property. They let the property management team run things and they did a very poor job. An important lesson for prospective owners…

We also included an inspection contingency and a contingency saying that the lower tenant had to be evicted before we took over the property. Again, the owner was not happy with this and tried to negotiate a better deal.

But we were only negotiating against ourselves and stood firm. Eventually they agreed to accept the offer.

The inspection

Next came the inspection. You can probably guess but there were a LOT of issues.

These included:

  • Asbestos in the basement
  • Faulty electrical wiring throughout all properties including the “renovated” one
  • Plumbing issues
  • Corner of foundation that needs repair
  • Flooring failing
  • Extensive damage to all counters etc

We spent a lot of time reviewing all of these issues and estimating cost of repair with our contractor. We ballooned our repair number to $60,000 in our estimate. With this in mind, we also dropped our offer to $205,000.

Now the numbers looked like this:

real estate deal
The cash-on-cash return now stood at 13.9%. Lower…but still above our 10% limit. So we placed our counter offer.

Again, the owner was not happy. But we stood firm and they accepted the counter offer.

So what happened then?!

Weeks went by. We got our mortgage commitment all set. And we waited…and waited. Without hearing from the seller’s team.

We started to ask about the lower tenant being evicted as our tentative closing date got nearer. After a long period of silence, their lawyer emailed asking if we would take a $1,000 credit for the lower tenant to stay. After we stopped laughing, we replied in the negative. An eviction process costs way more than this, not even including the value of our time and stress.

They relented and said they would evict. Then, weeks later, they emailed us saying that the lower tenant actually had a lease and they could not evict. When we asked to see the lease, they stalled.

So, they were either lying now or had lied before when they told us the tenant was month-to-month.

Ultimately, this was the final straw

The property no longer met our criteria. First, we were losing time value on our money in escrow, which was $10,000. We now were passing on other properties because we had our capital tied up.

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More over, taking over a property with a tenant that needs to be evicted for non-payment is a nightmare. Remember, we know from experience! This was a non-starter for us.

Third, we had lost faith in the seller and their team to act in good faith.

So, we withdrew from the contract based on the seller’s inability to meet the terms. Our escrow check was promptly returned to us.

In the end, we lost $800 for an appraisal and $250 for inspection. That’s not fun, but to us, it’s the cost of doing business and well worth the education we gained.

Then, we found a better property and went under contract on that one!

There are a few important lessons here

The most important is to stick with your criteria. If a property meets your criteria, lock it up. If it doesn’t walk away. And in a situation when a property stops meeting your criteria, get out.

It’s also so important to recognize that there are no called strikes in investing. It’s easy to get caught up in the sunk cost fallacy in a situation like this. We already put effort and time into this property and could have decided to just push through. But how does that make sense?

By cutting bait we were able to find a better deal. There are always more deals. Don’t get near sighted by just one of them.

Third, you are allowed to get creative with your offers. A lot of investors would not think they could place a contingency that a tenant needed to be evicted prior to taking over. But you can. In reality, you can add a contingency for anything. This gave us the flexibility to get out of the deal when it stopped meeting our criteria. Protect yourself!

So to me, this real estate deal that wasn’t is actually a win. And, if you would like to review our other properties, you can right here:

In the end

Progress is rarely a straight path. Especially in real estate investing. This experience doesn’t discourage us but just reinforces that our plan works, in good times and bad.

If you are interested in real estate investing, now is a great time to formulate your criteria for properties, find the right investor real estate agents, learn the 7 steps to get an investment loan to use leverage, and study the actual steps to get an investment property under your belt!

What do you think? Would you have taken this deal? What have you learned from a recent real estate deal of yours? Let me know in the comments below!

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    Jordan Frey MD, a plastic surgeon in Buffalo, NY, is one of the fastest-growing physician finance bloggers in the world. See how he went from financially clueless to increasing his net worth by $1M in 1 year and how you can do the same! Feel free to send Jordan a message at [email protected].

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