What I’m thinking about: Yet another miraculous, escape-by-the-skin-of-our-teeth story…
(For previous entries, check out the TN auction outcome, and the recent TX messy title deal.)
And no, we do NOT intentionally get ourselves in these situations, I would prefer to avoid these for the rest of my life, and hate the feeling of having our back against the wall, here’s what went down…
We offer transactional funding primarily as a relationship builder and because the IRR is unmatched when done properly. Historically, it represents less than 5% of our business profits.
Transactional funding is typically defined by having an A-to-B and B-to-C close set up, with a small gap between closes, or the title company is unwilling to utilize the C buyer funds for the A-to-B transaction, or there are two different title companies involved on both sides of the transaction.
In those situations, we will allow investors to “borrow” our balance sheet (in exchange for a fee) to complete the full transaction, and the goal is to reduce the risk of the full transaction pathway to as close to 0% as possible.
On paper, the mechanism seems simple, but in practice, complexities and various loopholes tend to accumulate. Half the time we’ve done these deals, some type of issue arises.
Traditionally, the lender in a transactional deal will maintain a first-position lien on the property, but the title will remain with the investor managing the deal through the ‘B’ portion of the close.
Instead, much to the irritation of most title companies, we require a double assignment for the A-B and B-C side of the transaction, so title passes through us.
This is a more conservative approach (something I’ve talked about extensively on the pod, search for ‘transactional’), because the most critical risk to mitigate is if the C buyer drops out for whatever reason.
My business partner routinely preaches maintaining control in deals. Not for the sake of a power play (our reputation of being a fair and flexible partner precedes us), but purely for downside protection, when s**t hits the fan, as it did here:
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~$190K infill lot (prime for a replat) just outside of downtown of a major metro, with an all-cash C-buyer lined up for double that price (unusual for a transactional deal), pending imminent survey.
$5K fee to us for a close within 5 biz days, $7.5K within 10 biz days, and $10K beyond 10 biz days, max of 30 total days before default triggered.
A-B side proceeded smoothly, but then survey got delayed and the title co. handling the transaction required our funding agreement documentation (never had that happen before), and then took EXCEPTION to it in the title commitment, which the investor working with us wanted to hide from the C buyer.
For the sake of article length, I’m forgoing a LOT of details, but I’m gritting my teeth in recollection as the mistakes piled up:
- Needed a new title co. as the A-B one was unwilling to remove the exception
- Survey continued to be delayed, and debate with which one to use with C buyer, based on requirements of construction lender
- C buyer began to drag feet with coming back to the closing table
- Communication with the investor who brought us this deal left a lot to be desired, to say the least. I don’t want to develop a track record about griping about folks we partner with, but suffice to say, we were reminded on why wholesalers have the reputation in the industry that they do…
30 days passed with the investor unable to line up a C buyer, so they defaulted on the deal terms.
Keep in mind we still had clear title to the deal, thankfully. But now we were unencumbered to attempt to sell it, and potentially pursue damages if we ate a loss.
Initially, I was less concerned with this outcome, given the margin we had with the initial C buyer, and an active market that appeared to support getting our principal back, at minimum.
This was right around the timing of the UnConference, when the concept of ‘consolidate focus’ was top of mind.
I recall chatting with Mike DeFrancisis (one of the savviest land investors I’ve met) about this situation, and he was like, “Dude, why are you doing these deals? Such a small part of your business, taking a ton of your time, and too much risk. Just double down on what you guys rock at.”
I hemmed and hawed, and rationalized that the potential profit made it worth it, at least in this instance, and if I had to make a ton of cold calls to get a deal done the following week, so be it.
(Again, I regret a LOT of decision-making about this deal…)
Cold calls/texts to builders hit an immediate brick wall, and the market was not supporting even my conservative expectations. (We didn’t list the property yet, was attempting off-market routes).
Also, in practice, realized that even if hypothetically we made $1M trying to sell a deal in this method, was NOT a way of doing business that I’d want to repeat, burning out almost immediately, and was forced to pause all other parts of my (two) businesses to try to solve this ~$200K problem.
Mike was right, I had totally lost focus.
The wholesaler who brought us this deal had offered to buy the property outright from us for our principal + transactional fee when he defaulted.
After testing the market in the above method, we went back to them and agreed, just wanting to get our money out ASAP, and get back to our normal line of business.
Even with significant and rather-scary legal protections in our favor, avoiding lawsuits is almost always the preferred route (speaking from experience).
Getting at least our principal out of the this deal was the #1 priority. If we could accomplish that cleanly, that was ideal.
(All of this was made worse by the fact that we were having our most profitable year by a longshot, in the midst of the worst RE market in at least 15 years, and we had already lucked out by escaping from nasty deals earlier this year. Having $200K at risk, with a downside risk of maybe a $100K loss in a worst case scenario trying to move this property, felt…terrible.)
Fast-forwarding, the wholesaler was unable to close on the property after multiple extensions (and excuses), and we ultimately decided to list the property via a flat-fee service (first time trying that, listen to my review here.)
Oh man do I wish we had done that sooner…interest spiked immediately and we quickly got two offers from quality builders that would net us ~$25-30K profit, going under contract with one today.
Frankly, I was stunned. My most recent deeper DD of the market seemed to point to a gross exit closer to ~$180K (eating a loss), and likely a longer list time, plus the limited interest from my previous cold calls/texts was not encouraging.
But just like our TN auction, when things work out in your favor, you don’t ask questions, and just work to close ASAP. Saving our year, saving our hard-earned profits! (Caveat: funds not in our account yet, but already have POF, low risk buyers.)
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Lessons:
(I write these articles as much for myself as for you all, to reinforce what we’ve learned, was so embarrassed writing the above, ton of holes to poke, even if worked out in our favor, need to keep getting better…)
Have a firm DD template for EVERY type of deal you do. We do so well with equity deals because we have tons of redundancies built in to ensure every last detail is reviewed (by multiple people). Transactional deals were more variable, based on funding amount, margin, and whether the C buyer had third-party financing. We didn’t have a set formula.
Unconsciously, it’s hard to give transactional deals as much attention since the profit is lower, and on paper, less risky. Have to fight that tendency tooth and nail.
Here’s the correct way, to follow EVERY time:
- DD the underlying asset as if you will acquire it. Would you be excited at the prospect, or sweating bullets? What’s the conservative market value if the C buyer drops?
- Get C buyer funds in escrow before you wire for A-B side, if you can. Not critical, but preferred.
- C buyer still has to sign off on closing, regardless of funds in escrow, there is not a way to close that loophole as far as we’re aware.
- Call, and grill, every single party (e.g. title co., C buyer agent, C buyer lender) involved in the deal to gauge the full procedure, and the ability/motivation of the C buyer to close in particular.
- A-B doesn’t close until all contingencies covered for B-C transaction (e.g. survey requirement, appraisal, POF for C buyer)
- Step up transactional funding fees for delays in B-C closing, generally at most significant risk when lenders are involved
Thing is, we’ve DONE all that properly before for other transactional deals, but we took for granted the cash-buyer nature of the C buyer, the margin, and location of the above infill lot, and we forgot that…
Rush is imaginary. Control the capital, control the timing. By nature, most title companies operate in a ‘last minute’ mentality, it’s almost comical. How many times have you gotten docs to be notarized a few hours before EOD, and expected to be overnighted to hit the closing deadline?
In this case, title co. was live emailing us that the A-B seller was at the closing table wondering where the wire was at, what’s the delay, they were about to leave, etc., and it’s REALLY hard not to feel that pressure, when hesitating may blow up the deal.
Just remember, once you send that wire…there’s no going back. Be really frickin’ sure.
“Don’t pick up pennies in front of a steamroller,” as my business partner says. Risking $190K to make $5K is almost always a bad bet. And in order to cover that risk, the correct DD procedure is extensive, as noted above. Only consider doing these deals if business is slow and you can afford the effort involved, with less chance of cutting corners.
Take title in between the A-B and B-C close. At least we did that part right, and it should be clear how advantageous that is based on our example. Yes, it’s more of a hassle for the title company, but imagine if we had a lien on the property instead of title. In a judicial foreclosure state (as we were), we would have been looking at a long, expensive, and time-intensive process to get control of the property in a downside scenario where the C buyer bails, and the investor is unable to perform.
Use performance guarantees to your advantage. In addition to title, we backed ourselves up legally with a PG. Particularly helpful in scenarios where heavy reliance is placed on the operator to perform (e.g. line up a C buyer). In practice, they can be difficult to enforce, but at minimum, they’re a scary stick to wave around. Very glad we had this in our back pocket, and still do.
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Have a deal you’d like funding on from a team who learns from, and applies, their lessons, slowly but surely (and blessed with good luck as well)?
