The 2 things you NEED in every real estate offer - Contingencies

Hey YouTube, this is Cody. I'm here with Christian, and this is an off day because I'm never on these calls and these videos on Tuesdays. However, today we're talking about real estate offers and contingencies. When you buy real estate, we want to buy the real estate, but in case something goes wrong, we want to make sure we have contingencies so we don't lose what's called earnest money. And your goal when you're buying stuff is to actually close it, but not everything goes smoothly, and so we have contingencies in place to make sure that we don't ever lose our earnest money deposit. Now, Christian, what is the big one that we use to look over all financials, look over the property, do inspections, and just make sure we're feeling good about it?

Feasibility.

Okay, so what is that?

So feasibility is a big catch-all. It basically just says, hey, these are the list of things that I need to go through to say that this is a deal that I want to do. This lets you look at financials, bank statements, verify that rents are actually what they said they were and expenses are actually what they said they were. So it gives you time for the financials, maintenance, repair, It's just a very general, is the deal actually feasible? When you start, you get to a point where it's okay, the seller said it's this, we believe it's this, we've come to terms that work. However, we need to make sure that everything that was said is actually true, and that is what the feasibility allows you to do.

So they give us a rent roll and then they give us some maybe estoppel letters that'll verify that the tenants are paying what they're paying and their security deposits are accurate, but How do we actually go about verifying the rents that they're collecting and saying they're collecting? Because they can give us what's called the T12, trailing 12 months of income and expenses, but that's an Excel spreadsheet and that can be modified. Where do we go to make sure that everything lines up?

Well, we go to the bank because the bank does not lie.

Ta-da!

And they can't. It's just actual ins and outs of an account. Can people try to modify stuff or try to be sneaky? Sure. But at the end of the day, there's no better way to look at something than what actually came in and out of the account. And you need to reconcile that with actual statements.

Statements.

If they give you a T12, you're gonna look at the income they said they brought in and you're gonna find where that matches up to the bank accounts. And you'd be surprised how many times that doesn't actually happen. You'll see a lot of them where it's like, hey, like a big red flag for me is if all the numbers they provide me are round numbers. Probably not true. They've rounded somewhere, they've estimated something. If you see a bunch of zeros at the end of everything, you know that they've made up numbers somewhere. Now the question is, do they round cents, a few dollars, or a few thousand dollars? You need to know exactly where the numbers came from. Thanks so much for letting me do that.

So it's not just about getting a physical inspection. You also have to do a financial inspection because when you're buying real estate, the goal typically for most people is to build their net worth and their passive income. And if the numbers are not where they were at least portrayed, then it's kind of hard to build passive income. You can get cash flow, but it just happens to be negative, and we don't want to do that. So this gives us an out in case that is the case. As soon as you waive feasibility, what we usually do is we have our earnest money due. We don't want to put earnest money up before we get to look at the property. We don't want money moving around because we don't want to put our money at risk. Even if we're in the right, someone can claim, oh, they didn't do this right, and then it goes to arbitration and it takes a long time to get your money back, and that's not fun. Just costs money and takes time, and both of those are very expensive. We want to have, in addition to all this, a financing contingency. Now, what property did we actually use a financing contingency on that we needed?

We did one for an 8-plex. It's actually the only deal we've ever got under contract where we didn't close, and it's a good thing we didn't because it turns out the numbers were bad. Well, they just weren't even there. They didn't really keep books on the property, so when we go to the bank and say, "Hey, will you finance this?" What does the property bring in? We ask for financials. Oh, you know what? Those financials that we had, we just have a little Excel sheet where we just manually put in some numbers. That's not financials. That's not bankable. Deal died right there. And because we have the financing contingency, we were able to get the letter from the bank that said, with the inputs that you have, we cannot finance this. You bring that back, we satisfy the financing contingency, and we're able to walk away without putting in any earnest money.

Some people are going to say, well, we don't need financing contingencies. We saw that in 2021. People are just waiving everything. Not super intelligent, especially when market conditions change. I know that never happens and rates never go up, except for when they just doubled. However, if you don't have your contingencies in place, you could be out your earnest money, and that's not a fun place to be. I'm not a fan of losing money. Most people are not a fan of losing money. Some people are. I mean, there are some flippers out there that are losing money hand over fist right now. They're like, I just stopped looking at the numbers. It was too painful. However, I'm not a fan of losing money. It's hard to get it back. So when we go out there, we want to make sure that we have our feasibility and we want to make sure that we have our financing contingency. Now, do we have a financing contingency with seller financing?

Typically, no, because I'm pretty confident we're going to get that financing.

Now, what that takes is when you sell property, you typically, at least in Washington State, it may be different in all the different states, but that's for you to check out based on your locale. You have to provide free and clear title, which means there's no liens on it. So when you're doing a seller finance deal, you have a promissory note and a deed of trust, or you do a real estate contract, which just creates a contract of sale, a little bit different because that doesn't create a loan. But when you're going out there and you're buying real estate, you need to satisfy the due-on-sale clauses on most loans, meaning you provide free and clear title. You're getting title without any of the preexisting loans that were there, meaning they have to pay it off. And so in a seller finance deal, you don't need a financing contingency because they're expected to bring free and clear title, meaning that the loan that they're giving you is just signing a piece of paper of a promissory note and deed of trust. So when we buy all of our real estate, we don't usually have financing contingencies. We had one for that 8-plex. Glad we had it because that wasn't a seller finance deal. But that is what that's there for. When you do seller financing, it's just a little bit different.

And also in the practical application of that, how would you waive financing contingency? The seller's not going to all of a sudden tell you, "No, I'm not going to finance because the building's not in the condition I told you it was." There's no way you would waive it if you had a feasibility because it turns out your bank is the seller and I don't think they're going to just decide, "No, I'm not going to let you pass financing." Yep.

And another one that you can put in there is actual title contingency. Make sure they can provide free and clear title even though they're supposed to. We get title insurance on everything. We've had issues where we bought a building and we paid $2 million for it, and then title gave us 0% of the building for $2 million.

Yeah, you want to make sure that you have all these in place. And any title company you go through, title insurance is going to be included, but you need to make sure you buy that policy. Yeah, you absolutely have to have that because that's happened to us. I can think off the top of my head of 2 deals, there's probably more. We've had little title errors here and there.

I'm not a fan of paying $2 million for 0% of a building. That is not fun.

That is hard to get a loan against. We owe nothing, but we owe $2 million. That's not what you want to see. And it just happened that it got recorded one way with the city and one way with the county, and they fixed it, but that's what the insurance is for. Last thing I want to cover here is when you're going through these contingencies, inspections. We don't always do that. Now, inspections, a lot of these items can actually fall into your feasibility study, which is great. You don't necessarily need another specific line item for inspection contingency, but you do need room to actually inspect the units, take a list of maintenance items, and go ahead and get quotes. Does it need to be a professional inspector every time? If you're new, I would argue yes. If you know your market, you know your properties, and you know what things cost, you just need to get your own eyes on it and numbers that you can trust. Cody, what do we do, and what pitfalls have we had from doing or not doing inspections?

Well, I mean, we've made some dumb mistakes, so we went bought a whole bunch of real estate, bought more multi-family buildings in the housing authority in Grant County. We don't do inspections in Grant County anymore because we know what it costs to fix stuff. Well, we thought we took that knowledge to Union, and then we had a whole bunch of problems happen literally at closing. We probably should have done an inspection. However, we're getting all that stuff fixed and we can afford it. We also went into it knowing we could afford to fix stuff up if it went wrong. However, we thought our knowledge was applicable from one side of the mountains to the other, and it's not. Live and learn.

Yeah, it is a little easier in Moses Lake. Majority, not all, but majority of our buildings are built in 1950s, and we've done a lot of renovations in those buildings. It's like having x-ray vision where we can come in and we can see right into the wall, and I'm like, I know it's gonna be one or two outdated panels. I know what the plumbing looks like. I know what the roofs are going to be like. We just, we've done the project so many times. We've been quoted for it so many times. And turns out most of the quotes we get are completely wrong anyway. So I know what the actual number is going to be. We don't need to go get a quote from Moses Lake because our numbers running a property management company and running our portfolio over there, I can almost guarantee my estimate will be better than whatever we actually get quoted by a licensed contractor.

Yeah.

So we're going to use those numbers.

The last thing I'd like to say on all this, just while we're wrapping up this video, it's good to get your inspections. We made the mistake not doing that on one of our assets just in a completely different location. It's okay to make mistakes, just don't make them twice. That's why we have that as one of our principles. However, when you're writing these offers and you're putting in contingencies, it's really important to use a professional. We are both real estate agents. He actually just let his license go. However, we don't rep ourselves on purchases. We work with the people that are the top folks in the space because we want our offers to be rock solid. We don't want to worry about holes in the offer. Some people go out online and try and get template offers. They're like, oh, I'll just use a template promissory note. Template deed of trust, template PSA. That is wrong. There are best practices. That does not fall under best practices. Will it cost you more money to work with a pro? Typically, yes. Is it worth it? Yes. So make sure that you're working with a professional so that everything you do is rock solid because you don't want a deal falling apart. You don't want to lose money because you tried to skimp out over a few thousand bucks.

In the how do you own it and how do you never lose it, that's a huge part of how do you never lose it. Have good legal. If there's a loophole in one of your contracts, you have a huge legal battle. It's either going to be expensive or you lose. I mean, that's the way that you lose a property is there's something wrong with the way that it was written. You have some expense that wipes you out or a lawsuit that causes you to lose the property. There's one thing not to skimp on. It's the legal work. Write great offers with great contingencies.

Contingencies.

Don't put down— Oh, come on. I can't say everything perfectly. We don't edit. But great offers, great contingencies. Don't put in large amounts of earnest money before you've gone through a feasibility. If you follow these rules, you're going to protect your capital, you're going to protect your investors' capital, and you're going to honor the "how do I own it and never lose this property?" That's it for today.

We'll see everybody on Whiteboard Wednesday live tomorrow from Moses Lake. We're going to go meet with some property owners and we'll keep everybody here posted. See you then.