BiggerPockets Real Estate Podcast - 858: Real Estate Gone Wrong: The House Flip That Fell Over (-$380K) w/James Dainard

Starting point is 00:00:00 Welcome to the Bigger Pockets Real Estate podcast. Today is the second of two episodes about deals gone wrong. Shows where you hear from Real Estate Pros about mistakes they made so that you don't have to, especially important in a challenging market like this one, where it's very hard to make those numbers work. Today, we're going to be diving right into a deal with our good friend James Dainerd, an expert investor and host of the Bigger Pockets on the Market podcast. James calls this deal humpty-dumpty because the property itself had a great fall. And it's also a deal where he happened to lose $380,000. And I'll say it again, being a strong real estate investor isn't about never losing money because that's going to happen. It's about being prepared so that when you do lose money,

Starting point is 00:00:40 you bounce back, have strong fundamentals, know how to react, and have a plan to get yourself back in the game. Let's get into it. So, James, when did this deal happen and how experienced were you at the time? I would say I was very experienced. This deal happened in the last 24 months. I've investing since 2005. One thing I can tell you is if you invest for a long period of time, you're going to run into these deals more regularly than you want. But lots of practice before I got to this major loss. Mine was a $380,000 on my bank account loss. So it was not on paper. It was a real, real hit. And it was just a deal that we bought in 2019 and we finish it up in the worst time you could ever finish a deal in the last 10 years in 2022. And,

Starting point is 00:01:28 And it took a clip. All right, James, what kind of property was this? So it was just a single family, our bread and butter, single family fix and flip. It was a 2,000 square foot house, major fixer, view property, great area of Seattle. But it's what we do on the regular buy house, renovate it and sell it for some money. It just went the wrong way this time. Ken, how'd you find it? We found it off market.

Starting point is 00:01:51 So this was actually a property that was listed on market for a couple different years, never sold, sent out a mailing campaign. and the seller kind of engaged with us and we scared it off market. We thought we got ourselves a home run deal. All right. And how much did you pay for this house? So we paid $550,000 for it. And this is in a class A neighborhood of Seattle. And at the time, after the renovation, we felt very comfortable that we'd be able to sell it for $1.1 million.

Starting point is 00:02:18 So a huge, huge spread on this deal. Okay. And what was the plan for this, Flip, Burr, Live and Flip? So it was a very, very heavy value add, fix and flip property. It was a two-bedroom one bath, 1,500 square foot house that we were going to add another 700 square feet into the basement. We were taking it all the way down to studs, rebuilding the whole house. Everything was getting done. We had a renovation cost of about $250,000 allocated for it, which is about $125,000 a foot.

Starting point is 00:02:46 And that's pretty typical for us on that size renovation in Seattle. All right. And how far into this deal did you get before things went wrong? You know what? It took me about nine months before I realized how bad this deal would. was going to get in the reason it took so long to know was, you know, in Seattle, you know, part of these deals that can go really bad, it comes down to debt costs and it comes down to timing. Time kills all deals, whether you don't make a decision or you do. And so we had bought

Starting point is 00:03:13 this property. And in Seattle, when you're doing a substantial renovation like that, you have to apply for permits. And these permits can take a long time before they issued, which we had planned for. But we didn't even start working on this property until seven months after we had purchased it. Wow. So was it just sitting like vacant that entire time? It was sitting vacant. We went through. We did our asbestos removal, our abatement, and our demo. And so we pulled the demo permit, did a couple other little permit items that we could pull over the counter as we were waiting for plan or view from the city. So yeah, it's a waiting game on these massive projects. You just kind of kind of push it through. You can do what you can. And then you have to wait for that permit, which is not the fastest thing in a lot of metro markets.

Starting point is 00:03:52 Right. And so it took about nine months to get that permit. That's when your deal. started going wrong. And that's why the deal went wrong. No, then it started getting real wrong. So we got issued full building permits, engineered. We had it designed all by an architect. And we started getting into the framing on this house. So we had demoed it. And when we demoed it, we saw that there was some cracks in kind of sinking to the foundation that was a lot worse than we had thought. But I've done countless amounts of projects where we are repairing structural walls, foundations. And so for us, we brought out our foundation contractor, our structural engineer. And as we started demoing and framing the house, the house started shifting dramatically.

Starting point is 00:04:36 And it literally fell over like the leaning tower, or maybe another nickname for this, the leaning tower of Leshai, because that was the neighbor that was in. The house all of a sudden went sideways on top of the hill. And we had to rush in with our foundation specialist. We jacked the house back up, re poured a foundation wall, and got it stable. So it was kind of like a, whew, we dodged a bullet. But what had happened is, you know, we had full building permits, but we did not have a permit to jack the house up and pour foundation wall.

Starting point is 00:05:10 Now, we could have added that in if we knew we needed to do that in the original, but that's a new permit at that point. So the neighbor was really concerned we were going to block the view when we jacked the house up. I met him there. I said, hey, just relax. It's going back down. We have full building permits. We went over the permits.

Starting point is 00:05:24 He said, everything's fine. but then 24 hours kicked in and he freaked out again, called the city, city came out. They said, this is outside your scope of work for your permit. You need to go back in for plan review, which would have took another nine to 10 months to reissue this permit. So then we would have been stuck on this house for 18 months, paying 12% interest in points to do the renovation.

Starting point is 00:05:46 Dude, that's wild. Genuinely, I'm not even kidding, like my forehead hurts right now. It's honestly, it's coincidental because it's been hurting the last couple days. But when you started telling me that, it's like, Ow, it hurts. Yeah, the pain just began to start at that point, Rob. Oh, really? There's more?

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Starting point is 00:08:22 So then we decided, hey, we got to rip the band-aid for real, right? And we're looking at our performance because anytime you're having a change in your plan, you need to reevaluate what you're doing. And so at this point, we looked at what we were doing. We knew we had to wait another nine months. We knew that the house value wasn't going to shoot up dramatically. And that nine months of cost is going to be right around $100,000 for that house. It's going to be about $80, grant.

Starting point is 00:08:44 That was going to destroy our performer at that time. In addition to, we had an additional foundation cost. So we said, okay, our plan doesn't look like it's going to work well. We want to get through this deal, but we want to go to highest and best use. That's what we're always tracking. And so we recomp the property. We saw that new construction were selling for the high two millions to $3 million range. And we were on a prime street with a view, and that's what sells, novelty sells.

Starting point is 00:09:09 And so we decided if we've got to wait nine months, then let's just reprimment a new house instead of the house. But we had already spent $100,000 in jacking up this house, reframing it, siting it, windowing it, and roofing it. And so that was just dead costs. So our basis now went up by $100,000. We had nine months to sit there to get our first permit, and we had to wait another nine months. So this $5.50 purchase price just turned into about a $750 purchase price very, very quickly with debt costs and the money that we already spent on this property.

Starting point is 00:09:42 We get our permit. It gets issued. It takes us about 15 months to build this property, which is about three to four months longer than normal because we're on a nasty slope with bad dirt. and we had to spend a substantial amount of money putting in our foundation, which we had accounted for, and we built one of the most beautiful homes that you can see, this really cool northwest modern, rooftop deck, concrete finishes, it was beautiful. But when you build a beautiful product, sometimes it doesn't matter.

Starting point is 00:10:13 And when we finally got to sell, we hit the worst possible market timing. And the reason we missed the market timing is actually, let me take a step back. When we got the building permit issued after waiting 18 months, it was right in rain season. You can't put foundations in a rainy hillside that's unstable during rain season. So we had to wait another four months before we could start the work. And because we had to wait that four months, it kicked the can down the road. And we listed right as interest rates started doubling rapidly. and our $3.1 million value got compressed by 15% very, very quickly because the market went into this quick free fall in Seattle, and we ended up selling it for $2.5 million.

Starting point is 00:11:00 That's $600,000 less than the comps were nine months prior from when we evaluated it. Once you racked out, all the purchase price, the bill cost, the debt costs, it ended up being a $380,000 hit. And not only that, what makes my skin boil on this deal even more, is we had a quarter, like, $350,000 just sitting there for three years, not only not making money, but losing money that time. And the velocity of money and time value of money was just shot at that point. So it's a $380,000 loss, but typically we make 20 to 30% on our money minimum for fix and flip on that point. So it's really like we lost $6 to $700,000 with the time value of money,

Starting point is 00:11:45 the loss of opportunity and the nasty hit we took and getting in the red out the door. Okay, so let me ask a clarifying question here. Were you all in on this deal at 2.9? And so you sold that 2.6 and that's how you lost your 380? Yes, yes. Because our debt costs, we had to hold this property for over 30 months, is basically 30 months start to finish, right? You said at 8 to 10% interest rate?

Starting point is 00:12:10 Yeah, it ended up being. So for the first 15 months, or, 14 months, we had flip debt, which was 12%, two points. When we went to issue a new building permit, we actually got our debt cost down to six and a half percent with a new construction loan, because we get really good friendly terms. But that's a floating rate when you're getting that kind of rate on new construction. So then in our performa, we performed it all the way out at six and a half percent, but by the time we were building it, we were up to 10 percent because the rates had jumped so dramatically. And so it was like an average cost of blend on there. But

Starting point is 00:12:45 Yeah, we had at least $250,000 to $300,000 in debt costs. We had a bill cost of around. It cost us on average. Usually we build a house for about $300 to $300 a foot start to finish in Seattle. But when they're on a hillside, it costs a lot more. So we're about $400 bucks a foot for that build, which costs us about $1.25 on the build. So with all the debt costs, the bill cost, and the cost of dirt and the waste of the renovation, we were into it for about 2.6, 2.7 because we have about 10% selling costs in Seattle.

Starting point is 00:13:20 Wow. Okay. And so what did you learn, man? Because that's a, it seems like you learned a lot of things a hard way. Give us a couple of lessons from this deal. Well, you know, looking back, I don't know if we did anything wrong. We were using stats and facts to make our decisions. And sometimes it's just bad, bad market timing. What I would have definitely done wrong, and this is what we're offering, especially on today's market, right? We have a flatter market. It's a little bit riskier. There's not as much upside in them.

Starting point is 00:13:47 It's all about structuring your terms up front right. So we knew going into this house that it was a nine-month permit with this owner. We should have offered to close on permits when our building permits were issued. We could have gave them large earnest money. We could have released it to them. That would have saved us about $100 to $110,000 in debt cost during that time. In addition to, I wouldn't have spent $100,000. thousand dollars on the renovation during that time as well. And so it would have saved at least

Starting point is 00:14:16 $100,000 right there. In addition to if we wouldn't have been in that deal and we got red tagged and we had to put the foundation in, the $100,000 wouldn't affect the performance so much. We could have stayed with our original plan and we could have took in that plan all the way through. It would have probably still made us even with the rates shooting up $100,000 because that price point didn't shift as much as the higher end. That, you know, around a million to million three in Seattle, it only came down five to eight percent rapidly when the rate started jumping. The higher end dropped a lot quicker. And so if we would have stayed with our original plan, the loss of value would have been a lot less. We would have been in and out a lot quicker. And if we

Starting point is 00:14:58 would have closed on permits, we could have done that all, but we just couldn't absorb that debt cost. All right. So, James, how has this deal helped you on future deals? Right now, what that told us was, you know, it was kind of the shift of, you know, every market's different. Every market shift is going to teach you a different lesson. And what this was was the indicator for us that we need to switch our whole business model up for the next 24 to 36 months because we were officially in a shift of a market, right? We went from a razor hot, high appreciating market to an instantly declining flat market really quickly. In a flat market, it's what it was in 2010 to 2014.

Starting point is 00:15:38 You have to nail your construction plans, and you have to stay inside that plan for you to make any money. There was no appreciation to save us, 2010 to 2014. It was, execute the plan, makes money. If you don't, you're not going to make any. And that was the sign that, hey, this is back to this market that we really got to get over. As we're writing our offers, really think about the plan, structure your offer around the plan, not just the perform and what price you're getting. And so it's a shift in how we do business.

Starting point is 00:16:07 we are not closing any properties on long permits as of right now. Now, we would have done it 36 months ago, because the market was so red hot and inventory was hard to find. You could factor in a little appreciation there and you knew it was going to rebound well. When you're going into flat, you've got to execute well. And so everything that we're closing on are long permits. Even this duplex I just bought recently.

Starting point is 00:16:30 I closed with a long permit. They allowed me access beforehand. It allowed me to get cheaper financing, the cheaper debt and financing is making the deal a home run rather than a loser. So it's really about structure for the next 12 to 24 months. And you're not doing any long-term permitting stuff. You're saying because, yeah, the market, you just can't really predict how crazy the market's going to get in the next year.

Starting point is 00:16:51 And so it's just an overall risky play to have such a long timeline for some of these properties. We're still doing it. We have, right now, we probably have like $6 million in land that we're contracted on with long permit closes. But we're contracted and not closed. So the risk is, a, we only have to put up a little bit of earnest money, give it to the sellers. That's better than a down payment on a property.

Starting point is 00:17:13 We get to keep our cash on hand right now as you're kind of weathering through storms, through your business and growing different departments. In addition to, we don't have to rack that debt cost. Debt is expensive. There is no more 6, 7% hard money cost or lending cost. It's 9 to 10%. So we can avoid that interest rate spread. And so we're still doing them, but we're not closing until the permits are issued or we can

Starting point is 00:17:34 start our work today. We don't want to start our work in nine months. That's good stuff. So, James, to recap yours, it sounds like time was the killer. The period that you don't have any control over when you're waiting on the city to come back or you're waiting on the weather to change. It was always something outside of your control that forced you to wait where you just had to keep making those debt payments. And so what you learned about your deals was do as much as possible before the deal closes or structure this in a way that you limit your risk and your exposure to time that's going to cost you money. James, anything you want to add? Yeah, like a $380,000 loss, that can be detrimental. That's a huge number on anybody. But the reason we could absorb that loss is because

Starting point is 00:18:18 we had such a red hot two years of flipping where, you know, if we look at our three-year average of flipping properties, we absolutely crushed it. This was just how it ended, right? You're going to And you can't time the market perfectly every time. But the reason we could take that $380,000 loss is because we take 10% of our profits and we stick them over in a bucket because we know that there's something coming at some point. Because even if you're a really good investor, I always say you're going to lose one out of 10. It's just going to go wrong.

Starting point is 00:18:46 And so you want to have that cash aside. We had just done really well on flipping. We had cash over here. We could absorb it. And then we also didn't let the fear of the loss trap us. Sometimes, like, we could have refinanced this property and took a nasty loss every month, trying to do a midterm rental, short-term rental, but, you know, try to break even. But we wanted to get our cash back.

Starting point is 00:19:05 Not only did we take the loss, we did get $200,000 of our own cash back to us or two to 300,000. We put that money to work since taking that loss, and we have been making 30% returns on that money. We've turned that deal now twice, so we've already made back half of our loss in the last nine months by reinvesting it. So don't get, don't get locked up. Don't get afraid. You got to figure out how to rebound back out of it. If we would have just been like, hey, this isn't for us right now, it would have ended with a loss. Right now, we've already made traction on it. I bet you by the end of

Starting point is 00:19:38 2004, that law, or by the first quarter of 2004, I will have that loss redeemed. And so you're going to take these as investors, but you've got to reposition, you got to reinvest and you got to regrow. Things go up and down. Make sure you get it back up again. All right. Thank you to all of the bigger losers on the panel. today. It takes some guts to get up here and share your L's, but we all benefit when it happened. So thank you a lot. If you'd like to get in touch with any of today's panelists, including Rob, where I head over to the show notes and you can get our contact information, as well as our social media. You can also find Mindy on the Bigger Pockets Money Show or James

Starting point is 00:20:14 on the on the market, Bigger Pockets podcast. So check those out as well. Any last words before we let you guys get out of here? Always be buying. Just buy your way out of it. If you get yourself in trouble. Thanks a lot, everybody. We'll see you on the next show. Thank you all for listening to the Bigger Pockets Real Estate Podcast. Make sure you get all our new episodes by subscribing on YouTube, Apple, Spotify, or any other podcast platform. Our new episodes come out Monday, Wednesday, and Friday. I'm the host and executive producer of the show, Dave Meyer. The show is produced by Ian K. Copywriting is by Calico content. And editing is by Exodus Media. If you'd like to learn more about real estate investing

Starting point is 00:21:10 or to sign up for our free newsletter, please visit www.biggerpockets.com. The content of this podcast is for informational purposes only. All host and participant opinions are their own. Investment in any asset, real estate included, involves risk. So use your best judgment and consult with qualified advisors before investing. You should only risk capital you can afford to lose. And remember, past performance is not indicative of future results. Bigger Pocket's LLC disclaims all liability for direct, indirect, consequential, or other damages arising from a reliance on information presented in this podcast.

BiggerPockets Real Estate Podcast - 858: Real Estate Gone Wrong: The House Flip That Fell Over (-$380K) w/James Dainard

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