Watch your step
My first five years of investing in real estate went rather well. I’d gone from buying a first rental property to a handful, all of which were rented to good tenants, the kind that always pay their rent on time and have very few problems.
Then about five years ago I made a mistake. I broke my rule that I’d never buy into a property I wouldn’t be willing to live in, and that deal has been terrible ever since.
Breaking this rule was actually a byproduct of another bad move: Not doing my own due diligence. I bought into a partnership that owned a small apartment building (eight units) two hundred miles from where I lived, and a vacant apartment building next door that was part of the deal, sight unseen on the recommendation of a business partner that I owned another property with. He was involved with this one and suggested I come on board.
When we talked about it he suggested that he had done his homework and everything was good. Trust but verify. I can’t emphasize this enough.
Immediately after I came in we had a big problem. The building had been financed by a hard money lender at an interest rate of 14% for a fixed period of time to renovate what had been a vacant building. And payment was coming due.
The lender would either get paid back the money or foreclose and take the buildings. At that point I was faced with a choice of walking away and losing $30k I had just invested.
Not one to cave, I set about turning things around. It took some time but I got it done. The lender actually hugged me when we made the final payment. I guess he knew something I didn’t.
While the eight unit building had been renovated (enough anyway) to be habitable and occupied, and a property management firm looked after it, it turned out the other vacant building was pretty much useless.
The area would almost certainly remain low income for the indefinite future. The cost to renovate it would have been multiples of what it would be worth. The lot was an odd size, and there were many zoning restrictions making it unsuitable for any other use we could come up with.
Meanwhile, all my partners (four of them at the time) were almost completely hands off – signs that this may have been part of the problem. After much legwork I managed to sell the vacant building for about $30k, providing 90% seller financing for five years.
Yes, the buyer would pay us $3k as a down payment and then make monthly payments of about $500 for five years. It was the best deal I could find. And amazingly, he’s still paying us on time on the dot after three years.
Then I managed to find a mortgage broker who found financing for us at an astounding rate of 9% fixed for 25 years. We were bent over the barrel but there wasn’t any alternative. This is what happens when there is no competition, which can occur when no lender wants the risk of exposure to an iffy property.
So there we were, proud owners of a dilapidated building housing derelicts, and mortgage holders of the condemned building next door – complete with dead birds and mushrooms growing through the floors.
At least we didn’t have to deal with it ourselves. Over the next few years, we just threw good money after bad. There were the periodic capital calls where each partner had to pony up their share of additional funds needed to float the building. Management would let us know there were things that needed to be fixed. Some things were, some things weren’t.
One partner was bought out of his share, and then there were four of us left. Each month I’d get reminded of this when I saw the management statement and reconciled the bank account.
It was mostly treading water financially and deferring maintenance. Frankly we were absentee, abdicated our responsibilities and ignored most of what was going on.
The main undertaking after the initial refinancing was another attempt three years later, after the initial prepayment penalty period had run out. Unfortunately, the appraised value took a dive from $300k at the first refinancing down to $192k due to two main things:
1. Continued decline in the condition of the property.
2. A halving of net income in the most recent year
The income reduction was partly driven by lost rent and repair costs due to a police standoff. A tenant of ours decided to discharge a firearm in her apartment. Someone called the police and when they arrived she refused to come out.
Some six hours later they tear gassed the apartment, busted down the door and took her into custody. Fortunately, no one was harmed. But the building’s value and reputation took another hit.
Then our hands off approach came to an abrupt end one day when I received a notice from the property management company stating that they were not going to renew our annual management contract because the building was too much hassle. Never had it occurred to me that this might happen.
While they had always seemed to deal with us fairly and gave us ample notice, it was still a shock to realize we were in a serious bind. We had essentially been fired as clients.
How would we find new management? How would we maintain the building? What if we couldn’t do one of those things, how could we sell it? It was underwater and we’d take another big hit to even sell it close to the appraised value.
Essentially I could have walked away a month into the deal for $30k. Instead, now I was facing a loss of an additional $30k after five years of hassle just to make the problem disappear. And walking away was not an option since one of my partners (the one that got me in this) and I had personally guaranteed the mortgage.
I had to go there and do my best to fix the situation. What would you do?