NEXT! KNOW WHEN TO WALK AWAY FROM A REAL ESTATE DEAL

The Bite Test

When should real estate investors walk away from a potential deal?

Not every shiny gold-colored object is valuable. Fool’s gold and fake gold can appear almost identical to the real thing. So can counterfeit $100 bills. That’s why we’ve all heard of the “bite test” to check for real gold and why stores have special lights, pens, and identifiers to spot counterfeit money.

There are a lot of potential real estate deals out there that aren’t the real deal either. Even dirt-cheap homes selling for $1,000 can turn out to be duds. And even brand-new shiny oceanfront penthouses selling for millions of dollars can be terrible deals in disguise. And more often than not, nothing is a deal unless you can land the right funding.

In real estate, the bite test is due diligence. And every deal should take you closer to your big-picture goals and meet your criteria for profitability.

The whole point of investing in real estate is to make the most of your money and time. So you simply can’t afford to burn resources taking big risks on properties that perform poorly. Each one needs to pass the bite test. And in many cases, you want to get a second opinion from a trusted “hole poker” (see Chapter 23) who will keep you in check.

When should investors walk away from a potential deal?

There are a number of reasons to pass on a property, and the earlier investors toss it back in the stream, the sooner they turn their attention to finding the real gold. Here are a few scenarios:

•The deal doesn’t directly help achieve your larger goals.

•You are unable to perform thorough due diligence.

•Financing costs put you at risk or diminish returns too steeply.

•Risks are too high.

•Profit potential is purely based on speculation.

•The numbers change for the worse.

•You lack the experience or resources for the asset class or property type.

•The property has some sort of oddity or pitfall that can make it hard to sell.

If physical inspections aren’t possible and contractor estimates or title insurance can’t be secured, you’re just asking for the worst-case scenario by moving ahead. To ignore the results of your due diligence, or skip it altogether, can get unbelievably expensive. If the numbers are too thin at the beginning, they are only likely to get thinner later. That can mean negative cash flow or having to pay money to get rid of a liability. That’s no fun, and it certainly breaks Warren Buffett’s golden rule: “Don’t lose money.”

Surprises can happen at closing, too. Sorry to say, there are some bad lenders out there—and they will count on you not walking away from your deal. They may try to up their fees or change the terms at the last minute. Bad financing from any lender, reputable or not, can break a good deal. That extra thousand or two can rob you of cash flow or force you to make a bad renovation decision. Sometimes you just have to walk away.

In other cases, sellers will refuse to permit the walkthrough before closing, or an occupant isn’t out. This presents massive legal and financial risks that most people can’t afford to take. There may be times when you have to bite the bullet on a few thousand dollars in expenses already accrued, but that’s likely better than taking on thousands of dollars in bad liabilities.

Taking a Hit

If real estate investors make enough offers and do enough deals, eventually most of them end up taking some hits. You can be a great boxer, but if you get in the ring enough times someone is eventually going to get a punch in, or even beat you. That’s only career ending if you give up, stay down, throw in the towel, and retire. On the other hand, if you get back up, get more punches than you take, and win more than you lose, you can still win in the real estate game for a long time. The key is minimizing those income hits. Sometimes it is a matter of blocking. Other times it is stepping into the swing, to intercept the punch early, to take the power out of the hit.

Performing as much due diligence as early as you can, having strong contracts and a good corner person (e.g., attorney, coach, or hole poker), and knowing when not to throw good money after bad are all ways to minimize damage. You may occasionally have to walk away from earnest money deposits and money invested in due diligence. That’s a cost of doing business. Don’t let it ruin your mindset. Learn from it, adjust your game, do better next time. It’s a lot better to take a little jab and bruise to the ego than to get knocked flat out of the ring.

Living to Fight Another Day

Truly wealthy investors often make investment moves that seem overly cautious to new real estate investors. Why? Seasoned investors “live to fight another day.” If you are still in the game, not over-leveraged and not speculating, you can always make a comeback even after a stumble. In real estate investing, this means preserving your capital and credit to make further investments.

So invest your time in due diligence up front, and don’t take a bad deal just for the sake of doing a deal. Act decisively and wisely, working with facts, not emotions and misguided hope. The real heavy hitters are the leading investors who differentiate themselves by being able to act quickly and decisively—and it’s all based on facts. It is said that the best decision you can make is the best choice; the second best is just to make a decision.

Plenty of Fish in the Sea

You must know when to walk away from a bad real estate deal, and be willing to do so. And just as important, know that there are more deals out there. Don’t do deals just for the sake of doing a deal. Do it for realizing profits and building wealth. There’s another house and another deal just around the corner.

TAKEAWAYS

List all the reasons that would prompt you personally to walk away from a potential deal. What are your deal breakers?