Summary: Welcome to the second part of our Real Estate Year in Review: 2020. In Part I, we covered the details of properties we sold in 2020 and learning pearls from each. In this post, we’re going to look at the first two real estate purchases (out of four) from 2020 (using our older properties as down payments). We’ve chosen to openly share our real estate journey this year with all of you in order to give all of you an opportunity to see what we’re doing and to learn from our experiences, so that you can become better investors yourselves!
This year was another really busy year for us in our real estate portfolio. We sold a number of properties, started making bigger real estate purchases, and even entered a partnership. In this second part of our series on our 2020 real estate year, I delve into the lessons learned from our the first of four purchases for the year.
The 32 Unit in Lakewood, WA
The facts: Purchased for $3,080,000 million in Spring of 2020
Some of you who read our real estate year in review last year will remember we mentioned that we were about to close on a 32-unit property in Lakewood, Washington. That was scheduled to close on December 31st, 2019.
It was going to provide us with a huge tax shelter. In fact, we had secured a bridge loan costing us $20,000+ just to ensure we would close in 2019. This was a good option, since our commercial financing wasn’t going to be completed in 2019. We also had three properties sold in 2019. The proceeds were sitting in with a 1031 exchange company, waiting to be part of the down payment for this property.
On December 31st, the seller failed to show up for his signing appointment. As a result, the deal did not close in 2019.
As you can imagine, there was a bit of chaos. There were calls between real estate agents. The seller’s agent was pleading for him to close. We called lawyers who called lawyers. It was a busy day in real estate purchases.
Losing this deal represented a significant loss for us. This meant hundreds of thousands of dollars in taxes we’d have to pay in 2019. There would also be the loss of three 1031 exchanges that represented several hundred thousand dollars in capital gains taxes that we would need to pay. Finally there was the time and expenses over the course of three months that we spent on the due diligence period.
Plus, the 32-unit was a great deal. The owner mismanaged it, and it was underpriced. It needed to be fixed up, but there was the opportunity for significant forced appreciation.
So the deal falling through on the last day of 2019 was not a great financial outcome for us. But this was a great example of the value of all of the mindset work we did in 2019 with the Tony Robbins Platinum Partnership.
First, Kenji and I sat back in the morning and got some perspective. We said, it’s ok, this is just about money. It could be much worse. In the end, we know we can make money from investing in real estate. We knew we could make this back with other real estate purchases.
Second, we thought maybe this was life happening FOR us, not to us. We would figure out how to come out of this experience even better in some way. Maybe we’d come out better real estate investors who learned something. We want to get close this deal someday on better terms. Maybe a better deal would come along later that we’d have money for to buy it.
Third, we created some solutions and started working on them. We got a lawyer, called our agent to strategize, and got insight into the seller’s agent. They also wanted this to close. We went and paid everything we could AHEAD of time for 2020 to create losses. This included signing up for a second year of Tony Robbins’ platinum partnership. We paid as many Semi-Retired MD independent contractors for 6-12 months of work ahead of time to get additional losses for our company.
Finally, we came together. The important thing is that we work together as a team to find solutions.
We also worked on finding perspective on why the owner had chosen to back out, and tried to understand his perspective for doing so. This allowed us to also think of solutions to the problem that might appeal to him. This was a chance to put into practice some of the work we had been doing on loving and understanding and empathizing with others.
In the end, it took three months to close this deal. But, it did happen. And, in a lot of ways, it was life happening for us.
We learned a lot about real estate law and contracts. We learned about negotiation, and worked with some great professionals to solve the problem. Also, we actually got the building for significantly less, because we were able to negotiate a large seller credit. In addition, we managed to create enough losses in 2019, that we didn’t have taxable income (and then that didn’t matter anyway because with passage of the CARES act there was the ability to take net loss carryback and shelter taxes from previous years). We didn’t have to pay for the bridge loan.
Not everything ended up being better. COVID hit just as we closed on the building, so then there was an eviction moratorium. This meant we couldn’t vacate the building and rehab all the units at once. Nine months later, we only have ten units renovated. With COVID, the bank gave us a smaller construction loan, which meant that we had to come up with more reserves. Having lawyers involved and going back and forth for three months with the owner takes a lot of our time and energy. It is something we will keep in mind for future real estate purchases.
In the end, though, I am grateful for this experience. It taught us a lot and in turn, it gave us an opportunity to share what we learned with students of our Zero to Freedom course. We are better real estate investors. We have even stronger mindsets. And this property is still a phenomenal deal that will end up cashflowing a significant amount. When we eventually go to sell it, I believe we are going to end up forcing appreciation of greater than two million dollars.
Learning pearls: If you manage your mind, you can get through anything! Focus on solutions, not problems, and you will be in a better place to fix things. People’s actions are either a cry for help or a loving response. In this case, recognizing the owner’s actions as a cry for help from a place of unhappiness and fear helped us deal with our emotions better than we would have. For those of you who are actively building your real estate portfolios, hopefully this real-life example shows you how a few small properties can turn into a much larger building down the road… and helps you see how you can do it yourself!
Now let’s dive into the second of four real estate purchases in 2020!
The 13 Unit in Tacoma, WA
Facts: Purchased for $1.62 million, Summer of 2020
Kenji actually started investing (speculating) in real estate back in 2001 with one of his best friends. Over the years, there were complications, and by the time Kenji and I started investing in real estate together in 2015, we had both concluded that we would never partner in an investment with anyone else besides each other.
Fast forward to this year, and we now recognized that this was a limiting belief. Just because Kenji had had one bad experience, didn’t mean all partnerships were bad. In fact, we saw that there could be positives of investing with other people. It was just important to think through potential issues and complications ahead of time.
Partnership wasn’t something we were actively searching for. We were happy to go it alone.
However, this summer, a pair of our students got a great deal under contract, but couldn’t secure commercial financing since they were out-of-state and also first-time investors. The husband-wife team was extremely persistent in trying to make it work – but they unfortunately could not find a lender – or another Semi-Retired MD student who wanted to buy the property.
Kenji and I eventually took a look at the deal, and we thought it had a ton of potential. There were a lot of sources of hidden value. Parking spots, under-market rents, ability to rehab and force appreciation, and a gutted unit in the basement were just a few. The opportunity for market appreciation due to location is the cherry on top. The property is in downtown Tacoma, two blocks away from a light-rail station opening in less than two years.
We also had one 1031 exchange (one of the duplexes mentioned in Part 1) that we were able to roll into this deal.
This property would be a project. It would require bringing in significant rehab funds and a lot of hours spent turning around the property. And of course there was the partnership.
This was a leap of faith for us, to be honest. But we are so glad we overcame our limiting beliefs, because it has been a really great experience.
Some of the things that we did differently (compared to what Kenji did in the past with his friend) were to buy the property as a tenants-in-common (TIC), establish clear roles and responsibilities, create mechanisms for resolving disagreements, and establish high interest lending rates if one partner could not come up with the funds for a capital call.
Kenji also has weekly planning calls with our students, planning and managing the rehab project. Turning this property around is going to be an almost year long process. It’s requiring a ton of real estate professional hours from both Kenji and our students.
It’s great because our students are going to achieve real estate professional status because of the material participation hours they’re racking up on this property and another one they purchased. They gain experience in a bigger apartment building with Kenji’s guidance, benefiting from the relationships we have with local contractors in the market. They have Kenji as boots on the ground when needed.
On our side, it’s awesome to get to interact with a student couple who are such amazing people. They are also more than willing to do more of the actual work when Kenji is really busy. We’ve also learned a lot about the tenants in common structure and structuring partnerships. Finally, we’ve overcome our limiting beliefs about partnerships.
When we rent this property at a premium after we fix it up in the next six months or so, the cashflow is going to be great, and there’s going to be a significant amount of forced appreciation. It’ll be fun to update you in the next couple of years when we sell this property and 1031 out of it into the next one.
Learning pearls: Partnerships can be great, just be sure you think through them carefully and address issues. Issues can be things like how to handle disagreements, assigning clear roles and responsibilities and how to handle loans when one part doesn’t have the funds to pay for repairs, just to name a few. Tenancy in common (TIC) structure is a useful way to structure real estate partnerships because both parties can 1031 in and out of a property separately. When you get the opportunity for forced appreciation and market appreciation, it makes a deal extra sweet.
Conclusion
There you have it, our real estate purchases in 2020! Part 3 will be next week, and I’m excited to share more with you then.
