Tuesday, December 5, 2017

Key to Investing Success: Get Good Deals and Avoid Bad Ones

My real estate mentor once told me that "Success is not only the good deals that you get; it's also the bad deals that you don't get".

Here is a recent example of a bad deal that I didn't get.

Perfect Find - Very Ugly House

My husband and I accidentally walked into an open house in Barrie, Ontario. The property was being sold by an estate. It was in a super rough shape. The house had to be gutted and re-built. Most investors would agree that this was the best type of an ugly house you can ever find - a flipper's dream come true type of a deal. Asking price was 250K. Next door houses were selling at 350K.

What Was Given 

In our situation we knew that:

  • We could find funds at 10% interest rate
  • We could complete the renovation in 3-4 months and sell the property in about 6 months
  • We wanted to make at least 25K at the end of the project
  • Real Estate Commission on sale would be 5%
  • Closing costs on purchase and sale would be approx. 2.5%
  • HST applied to real estate commission on sale would be 13%
  • Most prominent costs would be interest and renovation. Assume utilities, insurance, etc. would be part of renovation cost.

Good Deal Numbers

We confirmed with our contractor that the cost of renovation would be approximately 100K.

We added up all major costs ans saw that if we buy the property at 185K and sell it at 358K, we'll make our desired profit of 25K.

Given current market price of 350K, it was reasonable to assume prices will reach 358K by the time we will be selling.

If market remained the same and we'd sell at 350K, we'd make ~17K on the flip. This was acceptable to us.

We made an offer at 185K.

Bad Deal Numbers

There were 2 competing offers with the highest bidder being at 250K. Our agent asked if we'd want to increase our bid.

At 250K purchase price, we'd be losing 60K.

In order to make a 25K profit, we'd have to sell the house at 434K or 24% over current market price in only 6 month (48% annualized increase).

Betting on 48% annualized increase would definitely be a "buy and prey" type of investment.

We did not increase our bid and passed the deal. 

What Actually Happened 

After the recent mortgage rule changes, market actually rolled back from 350K down to ~330K.

If we purchased the house at 250K, we'd be looking to lose about 80K on the flip. Given rent and utility costs in the area, rent & hold on this property would be cash negative as well. 250K would have put us in a very bad position.

Looking back, it is obvious that our numbers did not make any sense at 250K. However, it was very hard to walk away from the deal in the moment when the events were happening. What if other bidders with much higher offers were smarter, more experienced and knew more than us? What if the real estate agent was right saying that this opportunity to get a property at 100K below market was a miracle? What if market would keep rising like a rocket ship and we'd miss out if we don't take the deal?

No matter what everyone else was doing, thinking, saying, or predicting, it was crucial for our success to stick to our own business and make the decision of not getting a bad deal, given the facts we had at the time.