#129 A Good Property Gone Bad

Foreign. Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey, everyone. Hope you're doing great. This is Peter, back for another episode. This week I'm gonna be talking about one of my losses, actually something that didn't go well. And if you're like any normal person, you don't like talking about your losses, you don't like talking about a lot of the big mistakes you've made. But looking back at something that I had to deal with, I realized how much it's helped me in the future. So I think it might be beneficial if I just shared about it. People ask me about this all the time, so I'm just gonna let you know how a good property makes, and I'm gonna tell you a little bit about the timeline and how things led up to it. There's some sensitive issues in here with some people that were involved legally and things like that, so I can't share all of the information, but I will share as much as humanly possible so you can learn from this and learn from my mistakes. Well, as many of you know, I have a nice portfolio of both active and passive real estate investments. For those who aren't familiar with the terms, active means you own your own properties. Passive means that you invest in other people's deals. The reason I like to do both and have a portfolio of both is that I think that both have their benefits and their cons. Right? Pros and cons. Especially when it comes to active investments. It's your own business, it's your own property. You have total control, the potential in a lot of ways for higher gains quicker, it's possibly there. But again, the downside is that it comes with a lot of time. Since you are in control, you have to make all the decisions, and a lot of the responsibility rests on you as the landlord, as the investor. On the passive side, nice thing is you're investing in someone else's deal, so you're leveraging their expertise, their knowledge, experience, and. And their time so that you can get returns. You're gonna pay for that because it's someone else putting in those things, but in terms of the time that you put in, it's gonna be significantly less. So there's always that question about which is better. You know, there's pros and cons. To both. And in this situation, I'm gonna tell you about a property that I wish I had not bought. But again, at the end of the day, I learned a lot from it. So this was back in 2019. In 2019, I was in a good situation where, you know, I was making good money from different investments, from different businesses, from even my job. And I was always looking for ways to shelter that income when it comes to tax benefits. And as many of you know, real estate has some of the best tax benefits available for people and investors, especially if you have something called real estate professional status. Real estate professional status allows you to shelter some of that income, especially the depreciation and the losses on that property, what might be considered paper losses. You might be able to use that to offset some of your day job income. Now, I'm not going to talk all about real estate professional status. Now. I've talked about it in some of my previous podcasts. But since I have that, since I qualify for that, I was looking to buy a property and take some of those losses, at least paper losses, and offset some of my income so I would have a smaller tax burden. And so it was getting close to the end of the year in 2019, I hadn't found that property yet. The good thing is that I have some other friends in real estate that look at properties. And in this one situation, this one friend who's a real estate investor, he said he could not or, you know, buy this property or he wanted to buy a different property, he had a property under contract, changed his mind, decided to go with another property. And knowing that person, that person is a very intelligent person, they're a great investor. I was like, you know, this might be a great opportunity because someone else has vetted this deal, someone else has looked at it, and so I get the chance to benefit from that. And that price point works well for me. It's in a great area, checks all the boxes, has great cash flow from day one. And I was hoping for some sort of like an 8 to 10% cash flow with massive several hundred thousand dollars of depreciation on it and in an area that was growing. And so it just seemed to check all the boxes. And again, a friend had looked at it. And so I got this deal in front of me. And if I'm completely honest with you, I probably didn't do the proper due diligence, meaning I didn't do all of the due diligence that I normally do when I look at a property, when I look at a deal the amount of time that I spend digging in, especially on the front end, is usually quite a bit, but I'm usually pretty good at it. I'm usually fast at it now, but pretty detail oriented when I look into a deal because I realize you make your money when you buy a deal or when you invest in a deal in this situation. It was closer to the end of the year. We were trying to rush to get it done. A lot of things were happening in my life with business. I knew this came from a friend and I probably without even knowing it, didn't dig in as well as I normally do. And so I thought it was a great deal. We were in a rush to buy it. We were under contract and I was trying to buy it by December 31st because I wanted to get it in before the end of the year to capture all of that what's called depreciation and take all those losses. So we got near the end of the year, the loan wasn't fully in place yet. I was trying to put on a long term fixed type loan that might be good for this type of property. The problem is we're getting up near the end of the year and if I was going to get that loan, they said it would extend into the next year. They wouldn't have a chance to do it. So I wouldn't be able to capture that tax benefit in 2019. So I said, what is my option, you know, or what are my options? And so the lender told me, well, we can find you a loan like a short term loan, which some people might see as either a hard money loan or a construction loan or a bridge loan is another term for it where you can get into this bridge loan and they'll lend you the money pretty quickly. It's going to be high interest rate, but you're going to be only in there for a short period where you can refi out of that into a normal long term loan that allows you to get it in before the end of the year. So you can probably know where I'm headed with this is that I was like, sure, that sounds amazing. I can go in, refi the property, be in that, you know, that short term loan for just a very short period of time. And so we got it done before the end of the year. Property was in my name. I was pumped. I was excited knowing that I'd be getting the depreciation and the tax benefits moving into 2020. Well, 2020 came and I remember it was the beginning of the year. There were there Was some confusion about the lender and about the refi process. Turns out that they kind of needed to start over again. And I was a little bit slow to it. This is the beginning of the year. So many things again were happening. And by the time I got around to setting up the loan, getting the process in place, that was closer till, you know, the early February stage. And I don't know if you remember what happened in February and March of 2020, but the world went crazy. The pandemic hit. Capital markets, lending markets, everything froze, if you remember. So the loans that I had in place, the loans that I were in process, everything froze. The banks decided they're not going to lend on these properties. I got stuck on this bridge loan, this bridge loan, just so you know, I was paying points on the front end, meaning that I was paying kind of fees to keep these loans for a short period. And then I was also paying a very high interest rate. You know, my interest rate at that time was somewhere like 12 to 13%. And if I added in those points, if you annualize all that, it was like north of 15 to 17% interest. But again, my point was that I was just going to have it for a very short period and then get into a stabilized loan. Well, Covid hit and next thing you know, I can't find another loan. I'm stuck on this short term loan which has high, high fees, high interest rates, and my cash flow is nonexistent at this point because of that. And so I learned a big lesson about how interest rates affect cash flow. But nobody expects to be on a loan that's like 15 to 17%. But any case Covid happens, things settle down. And at the very first opportunity, I look to refinance that loan. Because at this point, I'm not breaking even. I think I'm barely, maybe even, I'm even under at this point. My cash flow is negative. Now, I can float that for a little while, but this is not where I want to be long term. And so I started to the lending process all over again. Now getting into the lending process through that, these lenders are pretty thorough. They start, they want to ask you all about the property again, how it's performing and these kind of things. And when I did my due diligence for the property myself, it looked great and there would be no issues. Well, when the bank went to go look at this property, they dug something up. They found out this was on some sort of environmental cleanup list for that state in the northwest. It needed to be Cleaned up. And apparently this had been an issue for years. I knew nothing about it. This property, by the way, I didn't tell you it was about a 20, you know, two different buildings between the two buildings, about a 20 unit building. It was mostly residential. And then there was a small portion that was commercial where they had a laundromat. Now it used to be a dry cleaner back in the day. And apparently with dry cleaners, something I've learned is that they chemicals oftentimes make their way into the ground. And so it can be an environmental disaster. It has to undergo sometimes massive cleanup and things like that. And apparently that had not occurred. There were issues and that had been carried from that last seller to me. And I bought the property like that. And so that the bank said, if you don't clean this thing up, then we cannot lend on it. So what did I do? I found out, okay, well what's the next step? I got some, another environmental agency in here to figure out how much it's going to take to clean up this property, to get it where it needs to be so I can change, get my loan on it. And of course that took a little while for those to find those environmental people, those testing people, they did soil samples. Apparently they said it's going to take massive amounts of cleanup. I asked them how much and how long and they said, well, it might take a couple cycles and it's going to be about 2 to $300,000 a cycle. And I remember talking to them and thinking, all right, well how many cycles is going to be? And they said two cycles. And I said, how long is each cycle? Apparently each cycle takes about three years. So if you do the math, two to three, two to three cycles, you know, 200 to $300,000 each cycle. You know, next thing you know, my mind is just going nuts and crazy. And you can imagine the level of stress that I was feeling at that time knowing that I'm on this loan that's 15 to 17%, I've got an environmental disaster on my hands. And I remember going back to my broker at that time and saying, where did this environmental issue, like how come this thing didn't come up during the buying process? And we found out in the records that apparently it was there, but it was kind of not fully disclosed to me. And you know, probably we could have done a little bit more digging, done a little bit more follow up and we would have found it. And it turns out that again, it's something that we missed and something that was not unfortunately, disclosed to me at the same time the sale had been done. You know, there was really no recourse for me on that end in terms of. With the seller because they had actually given us the proper information. There was just miscommunication between myself and the broker. And so again, I didn't know quite what to do at that point. I'm stuck now at this point with a property that's underperforming because I've got a massive bridge loan still on it with, you know, I'm paying fees of 1 to 2% of the loan every few months, large fees. I'm losing money every single month, thousands of dollars that is draining my cash flow. I don't know what to do. We're in the middle of the pandemic. And honestly, I actually looked for help and I went to people and I said, I don't know what to do at this point. I've never encountered this sort of thing. And so luckily, I found my way to some lawyers who were willing to help me. Actually, there were friends that I kind of knew and friends of friends, and they, they looked at my case and they said, look, you've got a great case here, a situation where things were not disclosed properly to you, so why don't we go back to. To your broker and see if there's something that we can do and work out. Well, we went back to my broker, we turned back to that other company, and it turned out that we were negotiating for a possible buyback situation where they would buy the property back from me because it hadn't been properly disclosed, so we would avoid any sort of costly lawsuits. Having to go down that road. You know, that route might cost hundreds of thousands of dollars, years of our time. And we decided that possibly that the faster way would be to settle this and kind of, you know, maybe sell the property back to my broker. Well, while we're in the middle of negotiating all of this, at the end of 2020, now we're still at the end of 2020, I'm still on the same loan. All this. I get a text from someone that tells me, hey, you should check out this YouTube report. Isn't your property somewhere in this area? Well, I looked at the YouTube video, and it was a news report of my building on fire, and I hadn't heard anything from my property management. I called them to say, hey, do you know what's going on? They hadn't heard anything. And it turns out that there was some sort of domestic dispute in my property, perhaps, or There was some situation, we don't know, and it wasn't intentional, but there was a fire that broke out in that building and it burned out one of the buildings and it burned out at least half the units. Luckily, nobody was hurt, everyone was safe. Of course, that was a major concern. But of course, then what are we going to do about this property? It needs to undergo restoration, obviously repair. And this is all going on near the end of 2020, the beginning of 2021. We're still trying to figure out what to do in terms of the property and sale. I'm now, because of the loss of the units, I'm now cash flow extremely negative. I've got to pay for the restoration. I've got insurance that I'm working with now, talking to them daily. They're not necessarily being the most cooperative to help me out with fire. And so what I have to do now is I have to hire a fire somebody who specializes in fire insurance or getting claims or representing you for these insurance claims and make sure that you get everything you deserve. And they get some, of course, a portion of it. So they're incentivized to do so. So now I've got lawyers on this side trying to help me figure out what to do with the property, how to resolve this, and I've got lawyers on this side helping me with the insurance claim. And meanwhile, I'm anywhere from 10 to $15,000 short every month that I have to pay in terms of cash flow. And so what am I doing through all this? Obviously I'm paying the cash flow, but I'm trying to be confident, I'm trying to make sure that I understand that this is all going to work out well in the end. And how can I help it work out in the end. Ultimately, to make the long story short, I ended up selling that property back to the broker at the price I got it at. There were some settlements, money involved as well. And so ended up at the end of all this, my property got transferred back to the seller. All the insurance stuff got taken care of, the claims got taken care of. And when I tallied up everything at the end of the day, from the beginning of buying that property to the end, I basically broke exactly even. So over that whole ordeal, which was about a year and a half to actually almost a two year ordeal, I basically broke even. I grew a lot of white hair, but I learned so many things about real estate investing. I learned a lot of things about myself, what I can tolerate, what I can control. But you know, I Can really break it down to three things that I learned, and hopefully, you know, you'll learn from these mistakes. Number one, you never lead with any sort of investment with the tax benefits. Meaning that I think I rushed the situation. When I look back and I was buying at the end of the year the due diligence that I should have done. I didn't do it because I was really trying to jam it in before December 31st. The tax. I really wanted the tax benefits. And that was the major reason. I mean, it was a good property itself as well. But if I really think back to it, what really led it all was the tax benefits. Because of that, I shortcutted some of the due diligence. Number two, I kind of relied on somebody else's due diligence, meaning that I had somebody that I knew that took a look at this property, was thinking about buying themselves. They passed it to me. That gave me some level of comfort in some way, but that probably kept me from doing the proper due diligence myself. If I had looked at it as a fresh property, I let down my guard. And of course, something like Murphy's Law, something slipped through that was pretty big, that was very consequential. And I learned from that point. Doesn't matter if somebody sends me a deal. Yeah, I mean, maybe there's some more credibility. Whether it's active or passive, somebody looked at it first. But I still make sure it fits my criteria. I do the proper due diligence to make sure I don't get stuck in a bad situation. And then number three, the other thing is that I learned is that there's only a certain amount of time that I want to put in towards my active properties. I found out this property in particular drains so much of my time and energy. I know the potential is great for making a good amount of money with active real estate investments, but there's a downside to that too. And I really understood that situation now. That's why I made it very clear what my portfolio looks like. I'm very selective about what I keep as my active properties because there's only so much time, energy and effort I want to put into them. And when I think about acquiring new properties, I make sure that it's going to fit within that box of how much time and energy, energy and effort that I want to put in. And then the rest. I do passive investments. Cause again, I'm leveraging my time. If I had to compare my returns on this property versus all of, you know, any of the passive Investments I made during that period, it's completely different. You know, there are certain passive investments I made during that time where I've made, you know, close to 75 to 100% return on it within a year. Of course, that was the market at that time. So when I look at this property, there's definitely some aspect of opportunity cost, meaning that I had a lot of capital tied up in that property. I had a lot of stress, energy. But again, this is not to discourage people from making these type of investments because I made that investment, I came out from it, I learned so much. I picked up skills that I never had before in terms of resources, lawyers, connections, knowing how to do the proper due diligence, things to watch out for. You know, that market was good. And so because of what I learned during that period, I think I'm going to do much, much better in this upcoming period Right now where things seem to be falling, the recession seems to be happening, I'm going to be able to see the opportunities that are coming up ahead and I'm going to have the experience and actually the fortitude to be able to take advantage of those opportunities. So I learned quite a bit from it. I mean, again, I'm thankful in a lot of ways for this investment, even though it's probably the biggest mistake I've ever made in terms of real estate when, especially when it comes to opportunity cost. But again, I learned a lot from it. And my hope is that if you're listening to this, you, you'll learn from my mistakes. Every type of investment has carries its risks. Whether you're investing in the stock market, you'll see that people are doing quite well. You know, that carries its risks as well. That's why it's absolutely important to diversify. I still believe real estate is the best vehicle for creating cash flow, to create that income replacement, to create financial freedom to help you get where you want to be. You just have to try to minimize the mistakes, maximize the gains, learn from other people's mistakes and, and hopefully that'll serve you well. So I hope you enjoyed this. If you have any questions about this, let me know. Thanks so much. See you next time. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group, Passive Income docs, and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.