How not to buy your first real estate deal

My First Real Estate Deal

It’s time to get practical.  This is the story of my very first real estate deal and how it went wrong.  It was a fix and flip in Cedar Park Texas in 2009.  I picked this property out of a recommendation by my coach.  So I was at least smart enough to start with someone helping me out.  It was a brick 4 bedroom house in a sub-division.  The owner had fallen behind on his payments and was about to be foreclosed on.  His mortgage had about $179,000 on it and the home fixed up had a value of around $250,000.

You make money when you buy

Just like stocks, buy low and sell high.  As a rule of thumb for a fix and flip, offer 70% of the retail value minus the cost of repairs.  At the time I didn’t know that simple rule and I hadn’t discovered biggerpockets.com yet.  The seller was willing to let me assume his note which was around $1,800 a month and he wanted $30,000.  This would put the total cost basis up to $209,000.  There’s still $41,000 to be made in the deal right?  Not exactly.  Closing costs are going to be about 7% (6% to realtors, 1% in closing costs), so $17,500.  That leaves me $23,500 in margin.  That’s a 78% return, let’s rock!

Eventually all properties do sell, and your margin is going to be largely determined by what you bought the property for because that is the only thing you really have control over.  The cost to rehab and the sales price can be reliably predicted.

Pick an exit strategy

At the time I was pursuing a seller finance strategy which wraps the original note with a new one at a higher rate which would have given me a little more margin and a cash flowing property.   There are also fewer realtor fees in that scenario which could have saved me $15,000. However that strategy didn’t work out, as I could not find a buyer that wanted to use seller financing.  I lost three months trying to find one.  So I had to go with a backup plan which was to fix the house up to a retail level of quality, which fortunately could be done for just about $15,000.  However, my margin is now down to $8,500. It’s getting pretty skinny now, especially for the risk, as I paid the seller $30,000 and am carrying the note.

I finally sold it to the next door neighbor so her Mom could live next to her in a 4 bedroom house all by herself!  She watched the remodel and just got it in her head to have Mom move in next door.  She saved my newbie ass.  It sold for around $254,000, but 6 months after I bought it, tried to seller finance it, remodeled it, and then marketed it for retail sale.  After counting my carrying costs, I ended up making $700 on that deal which is a 4.67% annualized return and a lot of my time.

I had ‘new investor’ written all over me when I went into this deal.  I am glad I was able to help the seller from getting his credit trashed as we successfully paid off his note, but I never should have paid him $30,000.  Don’t make the classic mistake of being anxious to get into a deal.

Make the numbers work, and then add some room for mistakes

Plan out the entire project from beginning to end and include all of your costs.  Now increase them all by 10% and evaluate the profit.  Plan the project out with the maximum you can spend and break even.  That plan should feel pretty ridiculous, but you should be ok with it in case it happens.  Double your holding time.  Assume you will sell at 5% below market.  Assume repairs take twice as long.  Once you get emotionally ok with the worst case scenario you will have the will to pull the trigger.  Here is the plan vs. actual for this deal.

Plan Actual
Acquisition Cost  $30,000  $30,000
Note  $179,000  $179,000
Rehab  $5,000  $15,000
Holding Time 3 Months 6 Months
Carrying Costs  $5,400  $10,800
Transaction Costs  $500  $17,780
Sales Price  $265,000  $254,000
Profit  $45,100   $1,420 

*note the profit was $1,400 which I split with my coach

Don’t get emotionally involved

I felt bad for this guy that was about to lose his house.  He and his wife were getting divorced at the time, and I’m sure this was either the result or some part of that break up.  He really needed that $30,000, but ultimately I shouldn’t have given it to him.  I should have stuck to the rules and offered him $5,000 moving money but that’s it.  Under those conditions, this deal wouldn’t have been as risky.  I was one payment away from a loss on this deal.  People make mistakes and need to liquidate bad properties.  Investors take on the dirty work of rescuing them.  That is going to have a cost.

I am a total nice guy, so my instinct was to help him.  But I put myself at risk in doing so.  It’s certainly ok to help people, and that is what I try to do in all of my business dealings, but it has to make sense for both parties.  Don’t drown yourself saving someone else.

Say no, a lot

New investors often are anxious to do a deal.  As a result they don’t look at enough deals before taking one on.  Then that deal doesn’t work out, they have a bad experience or lose some money and quit.  It is in that moment that you must realize it is just a step on a journey and not the final destination.  Even if you do hundreds of deals, you are likely to do a few that don’t go well.  Learn from each deal and go onto the next one.

Look at at least 100 deals before taking one on.  By pure probability you will find a 1 in a 100 deal in that list.  You will get a feel for what the market is, and easily be able to spot a good deal when it shows up.  There are always more deals than capital.  Be patient and spend a lot of time looking.

Conclusion

I spent six months, and $50,000 to make $700, but I learned the foundation of the business.  I had to research deals, negotiate with multiple parties, source vendors, handle sellers, complete the rehab, market the property, and close it.  This was my first time for all of them.  It’s what I did with my evenings and weekends.  To date I’ve made over $500,000 in profits from Real Estate transactions and will certainly make millions more in my lifetime, but I had to make my first $700 with this deal.

Next week I’ll write up my best deal which will be a lot more fun.

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How not to buy your first real estate deal
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How not to buy your first real estate deal
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What do you think a good real estate investment is? Do you know what to buy, what the risks are, or how to make a deal work? There are many ways to buy real estate. This is my first deal and how it went wrong.
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Klavu.com
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