Bad Beats

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Welcome to the Real Estate Nerds podcast. On this Bad Beats episode, we will explore the human side of real estate investing with a seasoned pro about to make the legendary worst deal of their life. A deal isn't just the investment, it is also the person. Stay with us and learn what it takes to be the best investor.

Hi, and welcome to the Real Estate Nerds podcast. I'm your host, Scott Royal Smith. I'm the owner of Royal Eagle Solutions, your one stop shop for everything. Real estate, investments, tax, business, you name it, we do it here at Royal Legal Solutions. I'm here with a good friend of mine, James. He's going to be sharing with us a worst deal today. Guys, this is where we really dig and learn from the people that have walked a mile and those shoes before. Tell us what went wrong and why. What could they have done differently and what did they learn from it? So James, thanks for coming on the show here today. And what do people need to know about you, James, to get a good foundation for understanding this worst deal?

Yeah, thanks for having me on the show, Scott. It's awesome to be able to come and I wish I could share a good story, but I know a lot of times it's better to kind of learn from those more challenging ones. So what people need to know about me is that I do still work full time. Corporate supply chain manager. Got my start into real estate. Like I guess a lot of landlords accidentally when a prior company relocated me and I started renting out my house and have the same tenant eight years later, nine years, whatever it'll be now that she's renewing and. Yeah, and then as far as, you know, getting actively investing, you know, a co worker a couple years ago started talking about they were getting into it and I was like, yeah, you know, that sounds like a really good idea. And you know, kind of started more actively getting involved. I was in bigger pockets and just trying to learn more and that's when I decided to dive in.

No, that's awesome, James. So what does it look like, you know, when you're getting into this worst deal? Like, how did you get involved in it?

Yeah, so this particular worst deal that we did came to me through BiggerPockets contact who had a contractor reach out to him and I'm sorry, a wholesaler reached out to him. And so it's kind of in the area that I was looking and I mentioned something to my contractor about going to take a look at the property and he was like, I think I know exactly what property you're talking about. And he was actually working on a house for another investor, like, two doors down. And from there he was like, yeah, I'd been talking to that guy about buying it. And I was like, well, you either need to decide if you're going to buy it, because if you do, then I won't, but if I don't, he's going to go and try and sell it to somebody else. And he was already under contract on another deal, so he basically said, I just can't right now. And I was like, all right, so I can move forward with it. And so we did. So we went in and we bought it, and that was the last good news that we came out of that property.

What made you have the confidence in going with this guy? Like, where is there any lesson learned in the misplace and confidence? I assume that. That it's based upon this guy. Why it didn't go right. It wasn't something because, like, oh, the building.

No, it was just like, again, I don't know that there was really anything. I mean, so where. Where I invest in Wilmington, Delaware, almost all of my properties. I think my newest property is, you know, like 1930 something. I think my oldest is in the late 1800s. So they're old buildings. And so whenever you're going in, I mean, you can only see so much on the surface. Like, I mean, you can verify the knob and tube has been taken care of. You know, you can check if it still has, like, cast iron drain pipes, you know, so you can check for a lot of the. What I call basic stuff, at least on the surface. A lot of what people do, though, like, when they have still, like, the old plaster walls up, you know, you never know what kind of conditions behind those. Like, if they've got drywall replaced, sometimes you can make some assumptions that they've already gone in and they fixed a lot of stuff behind the walls, but they have the original plaster still in there. There's a pretty good chance that, you know, you're dealing with original things behind the walls, and then sometimes they're great, and then other times they kind of fall apart. So whenever you're going into these, you always kind of have to have that balance of optimism and pessimism because it's like, well, we know that things are going to go wrong. It's just, how bad are they going to go wrong? So there wasn't necessarily anything about the individual. I mean, he had owned the property for, I think, like, 25 years. So the only thing I Can maybe say, like if we had looked at it, is just people who have tended to own properties for a longer period of time, you know, do they put in all the maintenance that they need to, or if they keep it constantly rented, you know, is there just a lot of deferred maintenance buildup? That's one of the things that I think maybe we're taking a longer look at where, you know, now as a learning not only from this deal, but from several others that we've had that have gone similarly is really just more on our analysis and our due diligence of what do we expect might be wrong from a deferred maintenance standpoint point.

Okay, that's cool. Well, that's good to know about that one. So you get into the. You get into this deal and you lock it down. You have it under contract. I'm sure you're super excited about it at this point. When was your first inclination that things were going wrong?

What was our first inclination when things were going wrong? Well, we did end up going over budget on this project. So that was probably when we first started kind of seeing some things go wrong. So again, you always have those little things that kind of crop up. So like one was the electrical panel we knew needed to be upgraded because it was an old fuse box that needed to be upgraded to more modern breakers. And when we sent the electrician in, what we didn't realize is that not only did the box need to be upgraded, but it was too close to the main drain. And I guess according to code, it has to be a certain number of feet away. And so we had to move it. So not only now are we having to replace it, we had to move it, but the wires were too short. So we actually had to kind of run some additional wire, put in a junction box in order to kind of match it out. So we ended up with more expense there, which wasn't necessarily insignificant. Then when we went to go replace the flooring in the kitchen, we actually realized where there was a step down, there was actually some foundation issues, which it wasn't uncommon to have, like uneven. Cause they didn't necessarily always level out to be flat in these older places. So sometimes you have these weird step ups and step downs that are just based on how they put the foundation. So but apparently it was actually. So we had to actually rip everything out, all the way out the subfloor. We had to put in some new joists, vapor barrier, all kinds of stuff, and then rebuild the kitchen floor up. So once we started going down that I was like, okay, how bad is this going to be? And then again, it was kind of another issue and another issue. And once we kind of got it all done, we were super excited. And then it sat vacant for like nine months. So, yeah, it was the first time using a new property manager and, well, new to us. We were under the impression that they had some experience with dealing with our kind of property. And it was just, you know, like they kept on saying like, oh yeah, we're having people come through, they just don't put in applications. I'm like, well, what's wrong with the property? Well, we don't really know. I was like, well, then why aren't they applying? It's just taking way too long. Yeah. So what does that end up being?

Cause like immediately I call bs, right? Like people, people coming through. But no applications means that you're not actually doing any work as a property manager. You're not really selling the property. You're just doing something. Something else is going on. What did you guys look for to turn that situation around?

Yeah, so I wish I would say that we were smart enough to have turned that situation around. We did eventually get a tenant in there and again, it just took forever and ever. And they kept on telling us they were having showings. And I mean, we had had okay, success with this property manager since because this, we actually started another project after this house, finished it before this house was done and had it rented before we had a tenant in this one. So it was one of those, like, I guess maybe that was part of the reason why, like we knew they were doing something because they had managed to get a tenant into our other property. Now the other property was in a little bit nicer of a neighborhood that maybe they had some more experience with, you know, screening those specific tenants or whatever it might be. But yeah, it was just. I wish I had a better answer as far as having taken action faster, but yeah, we definitely didn't do that.

Okay, well, yeah, that's sometimes how that shakes out, you know, Is the property local to you or is it farther away?

Yeah, so all of my properties are down in Wilmington, Delaware. I live in southern New Jersey, so it's about 45 minutes away. So not, you know, super long distance, but not my backyard necessarily either.

In terms of like the construction projects where they kind of went, you know, like it was sounds like one of those classic stores. It's a never ending cycle of new things that are really expensive to fix. Is there anything in there that you could have really done differently when you're, you know, approaching that. Or is that just like, hey, those are the risks you run when you're buying a building like this? Is that that you can run into situations like this?

Yeah. So again, my contractor had already walked the property. Cause he had been familiar with it. Cause he was looking to buy it himself. So we walked it again. We put the scope of work together. Cause not only did we end up going, I think 15,000 over budget on the original rehab, but after we moved the tenant in, we've had another $12,000 in repairs since then. So we had now roof issues. We just had another roof issue that they submitted another work order for. We've had the furnace go. We had issues with again, cast iron drains cracking. We've had, you know, so a couple of issues, you know, more issues have come up even since then. And really, you know, when we have these older properties again, what we've always done is we've definitely, you know, we know we're going to have those expenses. Right. So everybody, especially if you read a lot of these, like, rules of thumb right around, you know, X percent for, you know, repairs every year and things along those lines, we've definitely gotten into the habit of trying to be more aggressive on those numbers because we know we have these older houses and you kind of never know what kind of repairs they're going to be. But even still, you know, when buying something like this, where you're already going in, you're doing a pretty significant rehab on the property. We didn't really anticipate some of these other things. So, you know, for us, it's starting to be like, okay, we need to plan for just a higher percentage. A lot of these rules of thumb, they're not designed for these older houses. And sometimes maybe you get lucky that you had a previous owner who did take care of a lot of that stuff behind the walls that you're not going to be able to see. But at the end of the day, more often than not, that's probably not the case. And so where we originally went in kind of on that 18 to 22% kind of budget for repairs, capex, we ran 2018 at almost 45%, 46%. So on top of that, again, our vacancies were much higher, not only in this property, but across the whole portfolio. So low revenues, high expenses, doesn't make for a good mix. So we're definitely trying to retool those assumptions. Because the other way we look at it is if we go too conservative we'd probably never buy anything. So it's trying to figure out what's that right balance of making sure we understand what we're walking into so that we'll still do deals, but just being having our eyes a little more wide open to what it is that we're actually buying.

Have you guys defined for yourself a criteria where that says, like, at this point we don't. We're okay not doing deals. Like, we know we need to make like this type of return with our money. It needs to be like, with this level of risk tolerance, otherwise we're just happy sitting on the sidelines or.

Yeah, definitely. So, I mean, we go in trying to analyze every deal that way, and again, we keep on upping what those criteria are. So what we've definitely tried to do is where we originally were only planning for, like, hey, we know we might go 10% over budget. We've upped that to 15%. So immediately when we go and do our deal analysis, if I think it's going to be a $30,000 rehab, I'm immediately tacking on $4,500 on top of that $30,000 rehab for extra stuff that we're doing. Going to anticipate finding we're building in a little bit more of a hold time. So we use private lenders. So where, you know, hey, we like to think we're going to be able to refi in six months. You know, we do the analysis assuming, you know, nine months or 10 months, you know, within our analysis of, you know, holding costs and things along those lines, you know, we're definitely also being more conservative on our ARVs, our appraisal estimates on this particular one. That was another thing that bit us in the butt. We own several other properties within just a few blocks of this property. So we thought we had a really good handle on what it was going to comp out at. Plus, even though we already own stuff, I still check the market comps every single time. We were pretty sure we're going to get appraisal at 95, and it ended up coming in at an appraisal of 83. So while on a certain hand it doesn't sound like a whole lot on 95, 93, that's more than 10% drop on your appraisal value. So, you know, when you take that into account, like, okay, we already put more money in, now we can't get money out. Plus we had a longer hold time. So we're trying to kind of take those learnings and say, okay, you Know, how do we protect ourselves as best we can against, you know, overages on that, on that. And again, while we may not hit all of those perfect storms, you know, what's that right number. And if only we do that analysis, you know, we're looking at a. Yeah, we're definitely in that like 20 plus percent return on our money that we want to be seeing. And then if it comes in lower than that, we're still able to be in an okay spot.

Cool, man.

The real ideal is to do the true brrrr method and put all your money in, take all your money out, wash your hands, and be able to walk away. But to be honest, after having bought 17 properties, I don't think I've done that once yet. So maybe I haven't found the right market or I'm just not smart enough, but have I found that deal to pull all my money out just yet?

Well, I think it's harder and harder. Right. I think that's where a lot of times where I get this into, you know, the markets become tighter and tighter to come into because you have more and more players that are entering the field. Right. So like, it's like those kinds of margins typically shrink the more times you have, like, increase in demand. Absolutely. Have a fixed supply. Right. So that's just basic economics 101, you know, into like, what do we expect to happen, at least in the mainstream of like, who's making money in the game right now? That's. That's typically what seems to be getting squeezed out. But that's what I was wondering about. I think a lot of people don't. At least a lot of people I run into don't think up. They're like, I want to make deals, you know, and they're like, if I don't have my money in the game, like, I'm losing money. And I was like, well, you can also just like actually lose, lose money, you know.

Yeah. And like, while it's not this deal, I mean, that's our cover.

Your deals, you know, the ones that go south and people don't talk about that enough, I don't think.

Yeah. And that's actually. So, like, we actually started a flip back in like August with the idea of being like, oh, hey, like, we've lost some of this money. You know, we looked at, you know, again, our cost of acquisition, where we weren't really burning everything back out. So we were like, hey, we'll go do this flip. We'll go and make 30 grand. We'll get Back whole, and then we'll be able to recycle, you know, that 30 grand through into other things. Well, now that flip has gone, you know, $45,000 over budget, and I'm hoping to get to the closing table in, like, two weeks, and I might break even, you know, and it's one of those, like, you know, I never in a million years thought that I'd be like, in that spot, given the profit margin that I thought I had built in. So it's like, not a great first flip to go into either to try to recover from the other situation.

Situation with the type, the amount of rehab that you ended up having to do into that flip was grossly out of whack, or was it like a big permitting issue or something like that that caused a problem in the flip?

So it was, again, another old house. It was definitely a big project. I mean, we went in with $120,000 per renovation budget. We knew that there was termite damage when we bought it. We thought we understood the extent of that. So I would say we probably had, you know, 5,000 of that was overages as part of, like, the termite damage. Then we had permitting issues. We also had the water main go, so we had to dig out the water main line coming into the house and get that replaced. We had delays with inspectors being on vacation. So, I mean, overall, I mean, the project took six weeks longer, which had me listing it right into the holidays, which is never a time you want to be trying to list the house, you know, at the top end of the, you know, the market range. And. Yeah, I mean, a number of other, you know, complexities, I guess, with that particular property.

Do you guys like. Like the older houses? Because that's where nobody's competing right now.

So Wilmington, Delaware in general, is just old housing stock. So inside the city proper, again, the city itself has been on the decline for 30 years, almost 20 years. So when you look at the history of the houses that were built, the majority of them, it was a decent booming city through the 1920s, 1930s. Then basically all construction kind of stopped until there was a little bit of newer construction in the 1980s. And then again, as a couple blocks maybe have burned down or had issues or whatever, they've rebuilt a couple of pockets here and there. But by and large, unless it's like the super nice areas where people are getting super top dollar, they're gentrifying all that, which there's only a small handful of, the housing stock is just that old now for the people that invest in, like, the county around it where it's a lot more of, like, newer suburbs and stuff like that. Yeah. Then you can get a lot more of that, you know, post 1970s, 1980s construction, which is a little bit more, you know, cookie cutter bread and butter that people like to deal with. So it's just the. What comes with the market we happen to be in, whether we like it or not.

Yeah. Oh, that's awesome, man. Well, I mean, there's a. There's an interesting story, you know, like, as we look at all these, I always like to end each episode with, like, a lesson learned from it. So one of the things that I'm. I've learned from our time here today, James, is just like the level of uncertainty when you're dealing with these types of deals. And it seems like the level of kind of like steely nerves you have to have with it to continue on investing. When you're dealing with these types of deals that can be really variable for you. It sounds like you put a ton of time and energy into vetting all the information that you could possibly bet on the front end. And like, with just the type of market and the type of business that you're in that there's just high volatility on things you can't control, which for somebody like me, totally would drive me crazy. I would be out of that market in a second because I'd be like, nope, don't like it. I don't do that well. I like really tightly controlled things. And it works for you. It sounds like you enjoy it and it goes for you. So I was wondering if you had to leave for a lesson learned or if you want to drop a comment and piggyback on something I just said, that's fine too. I see you smiling about it, so.

No, it's. You're definitely right. You know, it's. You know, we got into the Wilmington market because, again, it was kind of, you know, by chance. That's where I happened to have that first property. It wasn't the one we first started looking at. Right. So again, I live over here in South Jersey. That's where I originally started looking. But like, Jersey has really high taxes, so it's really hard to get things, the cash flow through kind of that brrrr method and things along those lines, unless you go into some really rough areas that I don't want to be in. So we kind of fell into that market. The numbers seemed to work and we just kind of ran with it. So as we do look to kind of grow and scale our business. We definitely have the intention of identifying other markets we want to go into and well, you know, I don't know that we would actively look for those old houses. Again. I think our experience kind of teaches us how to work on them. But one of the things that for sure we'd be looking for is, you know, properties that have at least a higher potential for upside on the appreciation. So a lot of our properties, their cash flow, they're gonna cash flow great. And the one thing I can definitely say is like on the long run, these will still be good investments. Right? So 10 years, 20 years from now, they will work out because we'll resolve all these capex issues. You know, the rents are really good. You know, we're all into most of these. Even this one, I'm all into it for $84,000. It rents for almost $1,100 a month. So like it still is, you know, well above the 1% rule. You know, we generally try to shoot for that 2% rule, you know, as far as how much we're into a property for. And so we do have that confidence in that long run. But you know, wanting to also be able to shift to maybe, you know, a higher class property where you have some more upside appreciation and kind of have the balance between the balance, you know, the P and L and the balance sheet. So I would say, you know, lessons learned is definitely, you know, when you're getting started, it's really challenging, you know, to balance that analysis paralysis with, you know, an expectation of reality and you know, just being able to be prepared for, you know, things that can happen. And do you have contingencies for that? Because it will come up and you have to be able to be flexible. And sometimes again that does require taking a step back and saying, you know, hey, what did I do wrong? How do I do things differently? And if that means taking a break and having to pause for a while, then so be it.

Awesome. Well, thank you James for coming on the show here today. Everybody. This is the real Estate Nerds podcast. I'm your host, Scott Royal Smith, the owner of Royal Legal Solutions, your one stop shop for everything real estate investor, tax, business and legal. I look forward to sharing with you guys here more in the upcoming weeks and more of our best deals, worst deals always remember to log on to the Royale LegalSolutions.com website, check out the new webinars that we're publishing all the time and ebooks that we have about solo 401ks, self directed IRAs, asset protection, estate planning, all the major things that are going to hit you as a real estate investor. We have all the great content booked up on there on the royalegalsolutions.com website. James, for anybody looking to connect with you, what are the types of people that you're looking to connect with and how's the best way for them to get in touch with you?

Yeah, so probably the best place to get ahold of me would be on bigger pockets and it's probably the best place to get me. You can also try to hit me up on my email. James Masati M A S O T T I at Quellacap Q U E L L e c a p.com so those would be kind of the two best ways to get ahold of me as far as who I'm looking to connect with. Really looking to at this point, kind of get connected with folks kind of in that similar level or who have already kind of leveled up to that next spot. How do you grow? How do you scale for somebody who's identified that next market where they go? I love connecting with my local investors and helping out some of the newer folks and that's great because I can help them learn from my mistakes. But I am also looking for those folks that maybe hear my story and feel like, hey, I've been there and I've been successful. So anybody who wants to chime in and help me get to the next level and learn from their mistakes, that would be awesome too.

Awesome, James. Well, thanks for coming on the show and everybody. See you again soon.

That's all for this Bad Beats episode. I'm your host, Scott Royal Smith with the Real Estate Nerds podcast. Did you see yourself in any part of that story?

I know I did.

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