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Episode Two: Executing on a Real Estate Strategy

I cannot believe it is already August. What a crazy and strange year it has been.

The real estate market continues its strong recovery, driven by low interest rates, buyers’ heightened desire for their own space, and better than expected economic data.

Unemployment positively surprised this morning and the rate now sits at 10.6% without work.

That is not a great number and it is still higher than the worst part of the Great Recession, but it is a far better number than 14.7% unemployment rate our economy experienced in April.

Remember, we went from 4.4% to 14.7% in just one month. That is unprecedented and scary.

Thankfully, there has been improvement each month to help instill confidence throughout the country.

The “Live” Series Continues

Now onto real estate!

Remember my live series where I planned to get back to you in two weeks?

Well, it has now been six weeks. Ha! Welcome to real estate sales where sometimes an escrow comes together beautifully, and sometimes it takes on a life of its own. This one falls in the latter category.

In short, the property we planned to sell is now finally closed. A two-week, all-cash offer, quickly turned into a six week, financed close.

If you missed Episode One, you can find the June blog post here.

In summary, this live series is covering a five-property portfolio that I hold a minority interest in and how we are adjusting the portfolio perform most efficiently while mitigating risks in the current market and economy.

Episode one generally discussed the points below:

  1. Selling one of the five properties.
  2. Timing the sale into what we believed would be a market rebound.
  3. Considering which offers to take.

I did not get into the WHY or strategy behind the sale, but that will be covered today.

What Happened in the Deal?

But first, you may be wondering what happened in the our duplex escrow?

As you know, we ended up taking a $20,000 discount to our asking price in exchange for an all-cash offer.

This buyer offered two options:

  1. The full asking price of $740,000 with financing, standard escrow.
  2. The option of $720,000 all-cash, close in two weeks.

I think the buyer was surprised that we went with the certainty of the cash, to be honest.

After inspections and the due diligence period, we discovered that the buyer had applied for financing on the property.

The buyer explained to me that he had the cash to close, but would appreciate if he would be granted an extension for a loan as he was in escrow on another property, and that “there is a lot of opportunity presenting itself in the market right now.”

Let me decode that for you…

Essentially this means: “I will buy the property if you let me obtain financing or I will cancel escrow and buy something else.”

Technically, this would be a violation of the contract, but with all contingencies still in place, good luck to us winning an escrow dispute. It was just not worth fighting.

Instead, we offered the buyer a two-week extension to accommodate financing in exchange for an additional $2,500 for that right and ALL contingencies to be removed (including financing).

The buyer accepted.

It was the next best thing as the buyer received his financing, while our side earned a little more and had the right to keep the earnest money deposit if the buyer failed to close escrow in two weeks.

Long story short, the financing was delayed, but with the earnest money deposit at risk, we were able to grant the buyer one final extension but enforce a per diem penalty with our deposit leverage.

The deal was closed a week late and both parties eventually got what they wanted.

That right there is a real estate deal. The ends achieved, but not necessary by the expected means.

It is not always pretty, but if you can accept that things do not always work out perfectly to plan, and you protect yourself contractually, you oftentimes can still get a successful result.

Expanding on Our Thought Process

After 11 years of ownership, one of the five properties in the portfolio is now sold.

So, why sell after an economic shock during a pandemic?

After looking at the overall picture, below are some of the main drivers that lead us to sell one of the properties.

  • Cash on hand for worst-case scenario.
    • The worst-case scenario is an accelerating pandemic, massive economic damage, and renters who stop paying rent. Is worst case scenario likely? No! But after the sale, the portfolio can pay all mortgage interest and expenses for two years if we do not collect one dime of rent any of our tenants.

  • After 11 years, it was time to improve the ROI/ROE of the portfolio.
    • With a decade of performance history, we had a firm understanding of what properties had out-performed and what properties had under-performed the market. Not to mention, what properties will continue to outperform? We concluded that it was time to divest from under-performers and re-invest into the out-performers that we believe will continue to deliver growth.

  • Utilizing ADU laws to become more efficient and more profitable.
    • As you have read in past blogs, ADUs are a big deal. There is a potential gold rush for investors to add more units to help address the housing crisis, while also earning more as a result. Click my past November 2019 blog on ADUs here. In short, we can double the units on certain properties thanks to the new laws. Why not double up on your out-performers?

  • Timing construction prices and mitigating risk.
    • After running the numbers, we could become more profitable with ADUs, but we need to build them! Construction prices are high and likely will not come down. However, if they were to come down, it would be about six to 12 months into a recession. That drop in building costs may or may not come, but it is worth a shot to free up capital now to take advantage of the potential down the road. And lastly, the original plan was to potentially build ADUs on all five properties using debt, but we decided to work with cash to responsibly manage risk in uncertain times.

I hope the above information helps you digest the motives and thought process behind these decisions. Also, my hope is that these points are helpful in aiding your decision making in the future as a real estate owner or buyer.

While the thoughts above are a valuable part of the process on how to manage your real estate or acquire a new property, the most important factor above all are…the numbers.

The numbers must make sense first and foremost. If the math looks favorable, then the additional drivers help to provide further context on when and how to act.

On the next “episode,” I will break down the numbers of how selling a property or two and constructing ADUs will greatly improve profitability, reduce risk, and increase exposure to better markets.

Conclusion

Thanks for following along on this continued out-of-the-box blog post. It might be a flop but hopefully, you can learn from my numbers, actions, and thought process.

The “live” aspect of this series will show the “wins” and “losses,” as demonstrated by the challenges with the first buyer, which ultimately resulted in a win. But, it very well could have been a loss and back to the market.

Throughout this series, you will learn aspects of income property sales, ADU laws, construction, being a landlord by navigating tenants, and rental projections for your investments.

This is fun for me to share and I hope you can enjoy it too.

With that, it is the end of the month, so I will catch you back here next week for my report on the South Bay July numbers.

Have a great weekend.

DRE: 01779425