You’re Not Saying Wow, Then…

Boy was Mike ever excited! He found his first real estate investing deal; a property he planned to keep as a rental. Knowing that Kim and I loaned money to purchase investment homes, he gave me a call.

Mike’s contract was a gem of an opportunity – at least according to him. The seller told Mike that six other buyers were lined up with cash money. If Mike wasn’t able to close within a week, the seller would let another lucky stiff…errrr…I mean investor…have the home.

Mike explained that the house was built in 1955, had three bedrooms and one bath, needed a good bit of work, the neighborhood was okay but not great, and like-kind houses in the area rented for $800 per month. The seller told him the home’s fair market value was $115,000, but he was willing to let Mike steal it for $89,000.

Mike was chomping at the bit with no time to waste. He needed a purchase money loan and he needed it now!

After digging into the guts of this “deal,” here’s what we discovered.

First, Mike estimated the rehab would cost $19,000. This meant he needed to borrow $108,000. So in raw numbers, if the rehab went perfectly – which rarely happens for a seasoned investor and never happens for a greenhorn – Mike would only pick up $7,000 of equity.

Second, Mike’s monthly mortgage payments would run $793. This amount doesn’t include taxes and insurance. Tack those expenses into the payment and it climbs to over $900 per month. In other words, before Mike even takes into account vacancies, repairs and management expenses, this “gem of an opportunity” will cost him more than $100 a month!

Third, because the house is older, only has one bathroom, and isn’t in the best of neighborhoods, it’s gonna be harder to rent – which leads to more landlording headaches. When it does rent, the tenant will likely be a bit rough around the edges – which leads to more landlording headaches. And there’s likely to be a good bit more turnover than normal – which leads to more landlording headaches. Oh, and lest we forget, older homes require more maintenance and repairs – which leads to more landlording headaches.

I asked Mike to look at this from my point of view – the prospective lender for his deal. Let’s pretend we’re able to move two years into the future. Rent wise, Mike has been losing $130 a month. The property has gone vacant four times. Each time this happens, he’s forced to spend time and money re-shining the house so it will rent – plus make mortgage payments to me. When he has tenants, they call regularly with problems – problems paying, problems with the house, problems with the neighbors. As Roseanne Roseannadanna always said: It’s always something!

I asked Mike, “After two years, with all these issues, isn’t it likely you’d be willing to chew your arm off to get out from under this deal?” He agreed that he would. Next I pointed out that if he got into financial trouble – which was sure to happen – and decided to give the house back to me, I’d be the one stuck with his mess! But here’s the thing: A lender doesn’t give you a house. They give you money. They want their money back – not a house!

Here are the two big lessons Mike learned: If you’re not saying “wow,” then you should be saying “whoa!” His second lesson was: Some of the best deals you do are the deals you never do!

People new to investing continually ask me whether they need a real estate investing coach. My answer is: kind of. I think the best way for someone to learn about real estate investing is to partner with a been-there-and-done-that investor. In other words, the new person goes out and finds a homeowner with an uncomfortable circumstance, then brings in a seasoned pro to help him or her with the deal. It’s a win-win opportunity for both sides!