E316 | Deals You Don’t Close: Why Walking Away Is a Power Move in Real Estate

Welcome back, everybody.

Today I want to talk about deals you don't do and how due diligence can save you tens or even hundreds of thousands of dollars.

You hear many people have been around real estate and I've aged myself and say I've been 28 years in real estate and some of the best deals you'll ever do are the ones that you don't close.

But today's episode is about one of those deal that looked promising on the surface, but once we really dug into all the details, it was pretty clear this one was a extended lawsuit, rip your hair out, kicking and screaming child from pulling them out of Disney World type of fight.

And I want to walk through how we caught it, why walking away sometimes is the smartest move that you can make.

Let's talk about the deal on paper.

The non performing note that was a construction loan.

It was part of a large pool we were looking at and the house was 50% complete.

And the tape, which is the Excel spreadsheet, noted borrower low on progress, needed more time, slash extension.

So when you see that, you're thinking, okay, and this was an area that had been hit by a storm, so the house wasn't impacted by it, but the area was.

So looking at it at first glance, typical rescue situation.

You give the person more time, maybe collect some extension fees.

I did a discount and let them finish the build and then sell it back on the open market.

That's typical.

What can happen these situations?

We've seen this and done this on many occasions.

Let's peel back that onion a little bit and talk about what the due diligence told us.

We get the collateral file, we start digging into the information and the servicing notes.

And the servicing notes had comments in there about an HOA lawsuit.

HOA had filed a lawsuit.

No paperwork or documentation within the collateral about this, but it was in the servicing notes.

Mechanics liens were in the servicing notes.

So we definitely wanted to pull title, see what was going on with those.

There's comments about permit issues and other items that really made this one be very hot, very hairy, I should say.

And as we started digging through this, essentially our first inclination is, okay, a lawsuit with the HOA is not something you want to be in.

Sometimes HOA's can demand the entire property be torn down and rebuilt and then as a lender really aren't going to recover from that.

Dive into a little bit about.

But the due diligence documentation really showed us.

So first a lot of sloppy note in mortgage documentation.

And I say that because there's a loan agreement with the borrowers and they had an LLC with three members and a husband, wife and a third person which I think was a child.

And the personal guarantee, they only had the child sign, which A is okay, throw them under the bus.

But in the same token, you know, a 22 year old kid doesn't have any assets whereas the parents had five or six other properties.

So that was red flag number one when we were looking at this documentation and who was underwriting this and clearly it appeared this was an institution that uses a lot of brokers and we see this a lot on these types of loans.

Brokers just push a deal through and get their commission.

A lender sometimes has no idea what they're really doing.

They're just trying to get the money out the door.

We dive into due diligence.

The title report, yes showed 150/plus thousand dollars in mechanical liens on this property which the borrower had been getting money and they had got about $200,000 so far of the construction.

But the lender was never collecting the lien.

What's called the lien waiver confirming the borrower has been paying the subs.

Where was the money going is the first thing.

So clearly mismanagement by the lender in regards to giving money, not tracing it, following where it's going.

Then we got copies of the lawsuits from the HOA and what was really going on and what happened is the borrower actually owns a home like three houses over within this community and property is owned by one of their LLC and they went and got a building permit in specific name but it didn't match the owner of the property because they on the building permit which I don't know how this got by.

It basically said XYZ owns a property.

XYZ is getting the permit.

Which as a homeowner, yes, you can pull your own permit.

Problem is the city never confirmed that they actually own the property.

So let me give an example.

I say I own one two three Main street which I don't.

My seventy investments owns it.

I go and pull a permit under Chris 70, say I'm the GC as an owner getting the permit because Chris 7 doesn't have a license but actually I don't own the property.

So city grew up there.

The lender again clearly should have picked this up.

Did not.

The HOA picked it up.

The HOA turned around and sued and said time out.

You're building this thing as with an unlicensed contractor, you not an owner Occupant and person also was a gc which was an unlicensed GC as well.

So clearly a huge convoluted issue.

So we ask seller of the note, hey, we need more information on this.

We're digging in and at this point we already know we're walking.

But let's get the information more for educational purposes.

This is sometimes not a bad thing.

People where like you look at something and you're gonna walk on a deal, I'll ask for some information.

Now I wouldn't say go spend all this money, ask for the information because it's a learning experience.

We're digging in and getting all this information.

And the sellers, the HOA is willing to work with you so you could go foreclose on this thing and just finish the construction yourself.

I don't know how many known investors out there have experience with new build construction.

Actually one, but people when they get in node investing get into it because they don't want to be responsible for the tenants, the toilets and the termites.

So why on God's green earth would a note investor want to take over a half built property unless they have experience with it and they're getting it at a ridiculous discount?

I will say yes, we have done this in the past on a property that was a little bit cleaner, but also a property that I'll give rough numbers builder probably spent a million and a half dollars in construction on the property that you get for 25 to 30 cents on the dollar.

This instance they were like 50 to 60 cents on the dollar which still not worth it.

But even if it was there just so many issues.

But what also really gave me a lot of hesitation was person that was doing this.

What experience did they have?

Did they.

Were they actually like a serious builder?

What was the actual status of this project?

Was it even constructed properly?

Now in some of the other deals, yeah, there was a third party GC and the property was well built.

This instance have no idea.

So really crazy type of deal.

Interestingly enough when we walked, this seller came back to us and was like why are you walking?

And they're like is it price issue?

They clearly wanted us off their books.

So could we have bought it at a deeper discount?

Sure, but we would have spent months, probably even a year fighting hoa.

Even though the HOA might have been okay, I don't know if they're okay, but I really wasn't in the process of even taking the time because here's the other component to this.

I'd have to get somebody in there to finish it.

But the guy who I'm taking this from lives two doors down.

Every time I send a sub there, he's probably going to walk over to property and then complain about everything, tell them what's going on.

Right.

And kill us from finishing this project.

But also, and a project has reputation and stigma sometimes to it.

Like in this case, the guy wasn't paying the subs.

You're not going to get those subs back to finish.

So you have to start basically all over.

And this was one that.

How much could we make on this deal?

Let's say it was a.

You could make a hundred thousand dollars on this deal.

Buying it for 100,000, whatever the case may be up for me, that's not even at a 50% return because it's gonna take years.

The upside isn't there, it's just not there.

Downside way too high.

Why would I want to take one of our asset managers and also myself?

Because I'm the one with the most experience on the construction side of things.

Sucker time away on a 300, 300, $400,000 home at the end of the day to fight this fight.

That's one thing.

Also that when you're looking at some of these super hairy deals or you're looking at something that is a lower value asset, understand the time it's gonna take.

Early in my career I this is one of the mistakes I would make is I would try and squeeze every penny out of every deal.

Realizing of spending way too much time and effort on that one deal.

Basically not make anything where if I just let it go, even if I lost a few bucks, spend that time on the other assets.

Be much better off.

For example, watch a video this weekend on management and team efficiency.

And what they're talking about is how people sometimes spend too much time on stuff they're bad at trying to get better at it compared to spending time on stuff they love that they're good at.

To get great at it.

And most people do the former where you really should be doing the latter.

Take what you're good at, be great at it.

The stuff that, excuse the phrase you suck at, get some help or find somebody that enjoys doing that.

That's how you build a great team is not by doing everything but understanding what is the most efficient, best use of time for process for everybody.

This is why in this instance we acknowledge that walked away.

And also just remember there's a difference between buying a challenge, in this case buying a lawsuit.

Because I looked at this that we would have been buying a lawsuit fast.

Honestly, without hesitation.

As I wrap up here are five takeaways that I just want to mention and talk about on this episode.

Remember surface level diligence Sometimes I want to use term useless doesn't tell the story.

We just relied on the tape not gone through the servicing notes.

You've been toast.

Nowhere would you have known about this lawsuit title report.

Actually didn't know it.

Sometimes they don't.

In this instance actually didn't read the servicing notes.

So important anything in an hoa double the scrutiny.

Approvals, plans, litigation.

There could be fines from the hoa.

Can't assume everything is clean.

Trust but verify it's a property that needs some work.

Remember, permitting issues aren't just paperwork.

They can lead to demolition notices, potential tear downs, fines.

If you're in Ohio, they're going to start fining you for grass, for windows broken, for lights broken.

Understand at a minimum and at a minimum it could be six figure construction liabilities.

Fourth is personal guarantees.

Nothing without something backing them up.

Never assume that the personal guarantee equals actual money to collect.

What does that person have?

Understand as part of that due diligence.

Who am I dealing with?

We've seen personal guarantees on loans we bought that borrowers have nothing else but that's okay, but you just need to know that up front.

Lastly, there's no shame in walking away.

Passing on a deal isn't a failure, it's disciplined.

Don't feel peer pressured into closing.

I'll stipulate make sure you have valid reasons to do it.

But a deal like this don't feel like pump your chest and bit and again feel like I want to take on this challenge sometimes mentioned from the outset best deals Once you walk away from my final thought.

Good investors know when to lean in.

Great investors know when to walk away his business saying no at the right time give you more money and sanity than a dozen good note purchases.

Thanks for listening.

If you want to see some real world case studies of deals was closed also ones we walked away from at over 70 investments calm.

We just don't always show the wins.

Don't show hard decisions because those are where real investors thanks for listening.