The following is a common moral, ethical and financial dilemma. For some readers there is no problem and the solution is very simple. For others, it may take some thoughtfulness to make the best decision.
A Investor came into the office and told me he had a closing coming up in one week and the seller was flying in from out-of-state to close the transaction. The Investor had negotiated what he believed to be a fair price and offered the seller $41,000 for a medium-sized two bedroom, one bath home. The property was unable to be sold in the inspection period even with a price reduction and a couple of emails to his buyers list.
I looked at the pictures he had of the property and noted that it needed central air, a roof, a kitchen, appliances, floor coverings, an upgraded bathroom and a complete patch and paint throughout. Essentially the rehab would easily be $20,000 to $25,000. After being repaired the home would have to sell for $75,000+ to make a modest profit. However, the neighborhood would only support comparable sales in the range of $45,000 to $65,000.
One option for the investor was to sit on the rehabbed property until it sold. However, within a ½ mile radius of this property there were 274 Distressed Properties that were already bank owned or where the lis pendens had been served – but none were for sale on the MLS.
In the same ½ mile radius, there were 470 additional homes where the owner was “Upside Down not in Foreclosure and the properties were Not For Sale”. This is a staggering 700+ homes that will have to come to market in the near future in a neighborhood of 1,100 homes.
So the dilemma is does it make economic sense to close on the property and try to wholesale it, or even rehab it for a retail sale? The property would have been a fast sell if he have offered the home in the upper thirty-thousand dollar range, but not at his $51,000 asking price. This would have left a rehabber who did his own work a profit spread that made sense. But that wasn’t the case, and the property had been contracted at too high a price.
The question was what should the investor do now that he is facing a closing that will result in a certain financial loss? Should he close and take a financial loss or renegotiate his purchase price with the seller? As I made the options clear to the Investor I could see he was getting emotional about telling the seller that he couldn’t close. He even offered to buy the property, but logically it didn’t make sense to close on the sale just because he didn’t want to hurt the seller’s feelings.
We discussed the exact words to say to the seller and how he might react. The preverbal question of, “What’s my liability?” came up. As a buyer, his Purchase and Sale Contract limited his risk to his escrow deposit of $250 plus costs his closing agent might have accrued for a total of about $500.
I had a great deal of empathy for the Investor as he struggled with deciding what was the right thing to do, close on the property and lose money, or default and walk away. It was not an easy decision for him, but he decided to walk away. He emailed me back later in the day and said the seller had gotten angry and was going to sell it to another investor for a slightly lower price.
All investors face this issue of the buyer getting buyer’s remorse before the closing. Realtors see it more often because the buyer is paying full retail for the property so it is a common issue and very frustrating.
Your only defense is to get as large a deposit as possible, get to know the buyer as much as possible before signing a contract, have the buyer show proof of funds, or a loan commitment, and have your buyers list ready in case the buyer changes his mind.
Some investors are so eager to rehab they overpay for properties and then because of inaccurate After Repaired Values (ARVs), cost overruns, end-buyer financing issues, or bad decisions, they have finished properties that can’t be sold so they become landlords hoping for a market upturn.
If you find yourself as a buyer facing a closing with a deposit at stake, there are only a few possible exit strategies:.
1. Close knowing you will lose money on the deal, but hope that you’re wrong and you’ll break even. (Not smart but it happens a lot)
2. Market the property as a wholesale deal for the inspection period and walk away if you can’t sell it. (Good economic sense, but may be emotionally stressful when you tell the seller. You’ll take a small economic loss, but it will probably be your smallest loss in the transaction)
3. Renegotiate the purchase price with the seller at the “eleventh hour” to get a better deal that makes economic sense. I suggest you show the seller why you had to do it. Requesting a price reduction to make the deal work, works about 30% – 50% of the time based on the seller’s motivation.
The seller taking a lower price is sometimes necessary and is a good financial decision. If the seller doesn’t agree, you should take the loss of the deposit, even if it is large by your standard. The seller may hate you but you can’t run a business by taking losses especially when it is just for the sake of saving face with a seller.
In summary, to make real estate investing a viable business, investors have to make uncomfortable decisions. Doing their research and property analysis carefully and thoroughly will make these decisions easier but there is always the risk of the market changing or unknown factors affecting the property’s price. Do what is right and always remember, it can and will happen to every investor in his career so always be prepared.
By Robert Peters