What happens when you do a bad deal?

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One of the saddest things about my business is watching people do deals which are undeniably stupid.

Want an example: How about paying 13x rent for a 5+ unit deal with a bunch of leverage and no plan for removing the tenants / raising the rents?

If you do a deal like that, here’s what happens:

  1. Your cashflow going in is very low or, if there are any maintenance issues, zero;
  2. You can raise rents by 3% / year, but it’s going to be a while before those increases begin to add up;
  3. You loan is locked for, say, 5 years, after which your interest rate will likely float up;
  4. When your monthly payments float up, any cashflow you had started to generate off the rent increases is gone, and you’re likely back to breaking even or having to pay to own the building;
  5. When you try to refinance to lock in a rate, you probably find that, with the new, higher interest rates, you don’t have enough equity to get a new bank to loan as much as the old bank did, leaving you a choice between living with the floating rate and putting more money into the deal to make a new loan work

We talk to a lot of owners who are in precisely this situation. They’re usually trying to sell their property for just enough more than they paid for it to cover transfer taxes, escrow and title, and brokers. And, often, they’re out of luck, because the property is basically worth what they bought it for (or less).

In light of the above, it continues to astonish me that people do these insane deals. I guess there are plenty of people in LA with sufficient money not to care about having to pay to own buildings that are supposed to be paying them. I’m not one of those people, and my clients aren’t either!

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