Walking Away From A Deal: Even When the Numbers Make Sense

by FI Fighter on April 13, 2015

in Real Estate Thoughts, Real Estate Updates

BayArea1

Over the years, I’ve updated this blog regularly with posts revealing more information about my latest real estate deals. Just a few months ago, I won Rental Property SH#3, and even back then, I predicted that it would most likely be my FINAL deal prior to checking out of Corporate America for good.

As readers know, I’m the type of investor (and person) who doesn’t like to set things in stone. I know very well that a person’s line of thinking and mindset are ALWAYS subject to change. How else can you grow and evolve as a person? I would definitely hope that I’m a much better investor today than I was when I started off 3 years ago…

So, I don’t like to shut the door on any potential ideas. Even though I don’t have any further plans to purchase any more rentals, I think I would be foolish to simply turn away completely from the marketplace and not pay attention to what’s going on.

Never say never…

Market Inefficiency

Recently, I was presented with another deal. It doesn’t hurt to at least listen, right? One thing that I’ve always loved about real estate investing is the inefficiency in the marketplace. Unlike the stock market, it’s very possible to find deals that are off everyone else’s radar, and being sold at a price heavily discounted to similar comps. For instance, even if the open market sets the price of a home at $700,000, all it takes is for one desperate seller to emerge for you to get in at a better entry point. If you and your agent are charming enough, perhaps you can even talk the seller down to $400,000… Not everyone keeps up-to-date on the market (some sellers couldn’t care less), and many have no clue what comps are actually selling/appraising for.

Latest Deal

Which brings me to the latest deal that was presented to me. As I mentioned in the previous post, the real estate market in the Bay Area is on FIRE. I used an example of a 3/2 Milpitas SFH that was listed for $675,000 and sold for $782,000, over $100,000 above listing. Insanity!

The pocket listing I got a hold of was for a 4/2 Milpitas condo being privately shopped around for $570,000. The sellers were partners who decided to go their separate ways and wanted to move out of the city. They didn’t want to manage a property from out-of-state, and desired nothing more than to wipe the property off of their books.

In general, if you’re desperate to sell, I’m even more desperate to buy! I browsed around looking for some nearby comps, and attended some open houses to see where the market was for a similar property. Without a doubt, I knew that I had a gem on my hands… This condo was also in very poor condition (my favorite!), so I knew that there was a lot of potential for value-add (forced appreciation).

Based on my experience from previous renovations, on a surface level, I would estimate that this condo needed $50,000 of work to get it up to my turnkey standards. Assuming the $570,000 purchase price, the all in price tag would be $620,000. With where the market is right now, the after-repair-value (ARV) should easily clock in at $670,000 or so, conservatively.

$50,000 in instant equity… That’s hard to turn down!

What Are My Options?

So, I knew I had a good deal on my hands. The next question I asked myself was whether this property was better suited as a flip, long-term Buy and Hold, or a candidate for my own personal residence. After running some numbers, surprisingly or not, I found that this unit wasn’t too far off from being cash flow neutral. Assuming it could rent for $3,200/month, with only some repairs, you would be out $100/month, with a standard 20% downpayment. For the Bay Area, at least for a desirable location in the South Bay, that’s about as good as you’re going to get with “cash flow” today!

A flip would have been appealing, but that’s very capital intensive, so I definitely would have needed partners to fund the project. As mentioned above, a decent flip would put the ARV of this property to at least $670,000.

Lastly, I don’t yet own my own personal residence, so that was also a consideration with this deal. Since my plans are to indulge in wanderlust in the near future, my course of action in the short-term would have required me to rent this unit out and bleed out slightly each and every month…

My Decision

It really didn’t take me long to make a decision. As a Buy and Hold, this rental clearly falls short of what I’m looking for from a cash flow perspective. Since I already have an ownership stake in 5 Bay Area deals, I won’t miss out on anything if property values and rents continue to surge upward. At this stage of the game, I have to carefully balance risk vs. reward. Taking on a cash flown NEGATIVE deal and depleting more of my emergency fund and stock portfolio would be a tough pill to swallow. As a Buy and Hold, no deal.

The marketplace tends to peak in the summer months, so if I was to market this deal as a flip, I would have had ample time to get the unit ready for primetime in July/August. However, right now I don’t currently have my real estate license, so things like agent commissions were something I seriously had to consider. When you skim 5-6% of the purchase price right off the top, that eats into your profit margins quite heavily. Once you add in taxes, closing costs, buyer concessions, etc., the deal looks worse and worse. Yes, I’ve always wanted to do a flip… But realistically, to maximize our profits, we would have had to hold the property for another year and gambled on the market appreciating even more! If we could flip this out in the open market at $720,000 today, I probably would have pulled the trigger… Similar to the scenario above, it ultimately came down to risk vs. reward. So, no deal…

The only play left to consider was to entertain the thought of making this property my future primary residence. From a location point-of-view, it makes perfect sense, as Milpitas is a very desirable community. But I do know that I want to travel the world. Very soon. And taking on so much more additional debt is scary, especially since this property offers no margin of protection since I know that I can’t make it cash flow as a rental unit. Again, no deal.

Risk vs. Reward

Good deals come and go all the time; don’t get too greedy! I was fortunate to be able to secure many quality real estate holdings by buying at a time of fear. Now that the market has done a complete 180, it’s very tough to still be able to locate gems today.

Up to this point, I’ve always shared with readers my latest real estate deals. This time around, I wanted to present a real estate deal that I walked away from, and my reasons for doing so.

This pocket listing was not a bad deal by any means! I even tried to pass it along to some of my investor friends. For some investor or homeowner out there, it could be the PERFECT deal…

And that’s what makes investing so interesting, unique, and fun. It’s hard to generalize things, because what works for one investor will not necessarily work for another. There are so many variables… You have to consider deals on a case-by-case basis!

In my own situation, I’m not going to push my luck any further. I have enough properties and I have more than enough debt. So, I’m sticking to the plan and continuing to go the route of the conservative investor — stashing cash and investing in large cap dividend growth stocks.

I am just about done playing in this bull market. I’ve also mentioned this before on numerous occasions, but it’s worth repeating — You can make money in a time of greed, but you’ll make a lot more in a time of fear.

Risk vs. Reward. I’m all about playing DEFENSE now!

We must protect these houses!! 😉

 

Update: The sellers weren’t so desperate after all. They quickly realized how dynamic the marketplace is right now and how it is a complete seller’s market. They pulled the deal at $570,000, and will now post it on the MLS. If they do some light rehab, my initial guess is that this unit will sell for $650,000. If the market insanity continues into July/August, perhaps $700,000 is within reach. We’ll see!

{ 11 comments… read them below or add one }

1 JCNo Gravatar April 13, 2015 at 11:46 am

I can’t blame you for walking away from this deal because it just flat out doesn’t fit for you at this time. I can’t blame you for wanting to be a bit defensive with your investments especially since your plan is to travel the world. There’s no sense in taking on unneeded risk. I think it’s just as important to look at the deals that are passed on as well as the ones that do fit. Investing isn’t 100% solely about the numbers.

Reply

2 FI FighterNo Gravatar April 13, 2015 at 1:20 pm

JC,

Yes, this deal didn’t make sense for me given my current situation, even if the numbers look good.

I agree with you that there’s more that goes on in analysis than just pure numbers. If I was planning on working another 5+ years in corporate, I probably would have made the deal.

It just doesn’t work for my own situation right now.

All the best!

Reply

3 Amar RichmondNo Gravatar April 13, 2015 at 1:14 pm

Fourth option could be get the property under contract and assign your contract to another investor. That way you can make some money off the deal and not have to own it at all.

Reply

4 FI FighterNo Gravatar April 13, 2015 at 1:21 pm

Amar,

That’s a great idea, unfortunately this property was brought to me by someone else so there’s no way I could wholesale it to another buyer.

Take care!

Reply

5 No Nonsense LandlordNo Gravatar April 13, 2015 at 7:35 pm

Keep your powder dry. The prices cannot appreciate faster than wages forever. Housing prices, and rents, are a function of wages.

If interest rates go up (and taxes, insurance, HOA dues, etc.), property values go down.

Reply

6 FI FighterNo Gravatar April 14, 2015 at 2:56 pm

Eric,

Agreed, this game can’t go on indefinitely. I’m stashing powder now. No more playing hero ball.

Cheers!

Reply

7 StanleyNo Gravatar April 14, 2015 at 12:04 pm

Hey just wondering what pocket listing means ? how do you track these properties ?

Reply

8 FI FighterNo Gravatar April 14, 2015 at 2:57 pm

Stanley,

It’s a real estate slang for listing not on the MLS. In essence, an under the radar deal that the marketplace is not aware exists.

Some sellers prefer not to go through the normal channels when selling. In most cases, this is due to the need to liquidate quickly.

All the best!

Reply

9 StanleyNo Gravatar April 14, 2015 at 3:25 pm

Thanks. Another Question. Is it a good idea to take a HELOC out of your primary residence till 90% LTV to keep cash available for downpayment toward second home/rental property when the bay area market cools down ?

Reply

10 FI FighterNo Gravatar April 14, 2015 at 3:42 pm

Stanley,

That’s a tough question to answer because it ultimately depends on your own investment goals, strategy, and risk tolerance.

Leverage cuts in both directions, but if your plan is to hold out until a downturn, the use of a HELOC to fund further investments is strategy that many investors do make use of.

In my own situation, I completed 2 cash out refis earlier this year, with the intent of pulling out cash for any future dips in the market. For a cash out refi, I was able to get 75% LTV, which I was more than overjoyed with… 90% LTV is about as high as any figure I’ve ever seen, whether for primary or investment property.

In any case, it would be a good idea to consult a professional before making any decisions.

All the best!

Reply

11 Financial SamuraiNo Gravatar April 23, 2015 at 12:42 am

What’s your cash hoard now? I thought you were doing HELOCs to buy property? This deal seem like it would have put you over the edge no?

Reply

Leave a Comment

 

Previous post:

Next post:

Copyright © 2012 FI Fighter