- Posted July 10, 2014 by
Hubris Is Fatal: Knowing When to Walk Away from a Flip
From the time I had put my first property under contract in 2002 to three years later in 2005, I had experienced phenomenal success. My net earnings up to that point were over $1,000,000 with approximately thirty homes sold, closed, and recorded. But 2006 would forebode the worst to come. Even though I made about $300,000 in 2006, the following year of 2007 and 2008 was essentially a clean-up operation on some properties I purchased in 2006. That was around the time that I would close five homes that clearly deviated from the investment dogma I had established and adhered to like a monk.
When you put a property under contract and it takes nine to twelve-plus months to come to fruition and buildout, and then to the instant when you are ready to close, it takes a lot of discipline to just walk away from something that you are hoping is a good thing. Even if your instinct tells you to take a “pass” on the home, the wishful thinking part of your conscience wants to believe that the market will pick up, and that if you buy and close the property, and just market it for a few months, you’ll bring in the minimum $30,000 to $40,000 net you are looking to make or you’ll get a bidding war on the property, or you’ll market the living bejesus out of the home and everything will be all right. Nonetheless, your mind comes up with half a dozen scenarios as to why it makes sense to close the property.
But the fact is that it’s difficult to just walk away, especially in light of the last nine to twelve months of waiting and expended “effort,” if you can call it that, for this baby to mature. Just walking away from a potential $30,000 to $40,000 net profit, or in some cases substantially more, is easier said than done.
Unfortunately, I did close five properties in 2005 that I should have just walked away from. More specifically, two of the five properties hit me especially hard. First and foremost, two of the five homes, which were in Burbank, California—an expensive suburb of Southern California—deviated from my new tract home methodology in that they were not priced in the $200,000 to $400,000 range. They were priced at $550,000 and $570,000 respectfully. Second, these two condo homes were not in the typical medium priced/high-growth areas that I had built my practice on but were in high-priced Burbank, which is an upscale, television entertainment community in Southern California. What I had built my investment philosophy and target market on was known as the Green Triangle—as I dubbed it. As viewed on a map, the triangular juxtaposition of Phoenix, Las Vegas, and Riverside, California, represented a lucrative return that flowed the color of money. Hence, the inception of the Green Triangle. Third, the build-out time was not ideal and was shorter than I typically required in order to ride a wave of appreciation—which started from the time I put the home under contract until I actually signed the loan docs and closed it. Fourthly—and keep in mind three strikes you’re out and this was the final nail in the coffin—I relied upon sketchy market data and comps to justify the value and eventual close decision on these two Burbank properties.
As a member of three MLS services in Phoenix, Las Vegas, and Southern California, part of my closing decision methodology necessitated a check of comps to determine where the homes were trading at. This was done to determine if they were worth closing. To not properly vet the comps out, is like a doctor putting his patient under anesthesia without checking his vital signs first. If the comps didn’t signify enough of a spread between what you would be paying for the properties and what similar properties were now closing at, not just selling at—because that’s an extremely different measurement of reality—then short of an act of God, it didn’t make sense to close the deal since there was very little profit to be made.
In this case, I bought the Burbank properties at $550,000 and $570,000 respectively, and conservatively speaking, the properties would have to be a $625,000 resell deal in order to net $30,000 to $50,000, worst case scenario. However, after checking the comps, there were two homes at the same development that sold within sixty days of my expected closing date that were resold at $625,000 and $649,000 respectfully. Bingo, I thought. The comps were there. I’m clear to close on these babies, so let’s go to escrow and sign loan docs.
If you’re trying to guess what’s wrong with this scenario, it’s the comps, stupid! And I direct this derogatory comment to myself for the problematic and indefensible decision making I employed at the time, not to the reader of this book.
The problem with these comps, the $625,000 and $649,000 ones, is that there are only two of them! Case in point: when you’re getting ready to close a home, and in this case a half-million-plus-dollar home and $1.1 million worth of investment product, you better have more than only two comps. At a minimum, you better have at least five or six comps to make a well-reasoned and sound decision. This is especially so for a more expensive flip candidate, such as these two Burbank properties.
Considering the mortgage debt consequences if these two homes became two very hot potatoes that were unloadable. As it turned out, it took a little over a year to sell both properties, and with monthly mortgage debt of approximately $10,000 for both properties combined, my net loss was $125,000-plus.
This was a real loss, mind you, not a paper loss that you never really feel, but a real actual and painful loss where your bank account or bank accounts, depending upon which one you’ve depleted first, is actually debited $10,000 a month continually until you actually close the properties.
In retrospect, I should not have bought and closed the two Burbank properties in the first place. But since I did close the properties, I should have gone to plan B, and that would have been to probably walk away from these properties four to six months after I closed them, or at least executed a couple of short sales. A more perfected exit strategy may have been to sacrifice these two liquidity cash killers early on in order to save the other properties, that being primarily the nine condo units and the four other bad flips, all of which were eventually lost twelve to twenty-four months later after I had brought the Burbank properties to market. The loss of 13 properties almost seems prophetically fitting in a superstitious way. Perhaps I accidently broke a mirror in one of the many tract homes.