Real Estate Gone Wrong: The House Flip That Fell Over (-$380K)

David:
Welcome to the BiggerPockets Real Estate podcast. Today is the second of two episodes about deals gone wrong, shows where you hear from real estate pros about mistakes they made so that you don’t have to, especially important in a challenging market like this one, where it’s very hard to make those numbers work.

Rob:
Today, we’re going to be diving right into a deal with our good friend, James Dainard, an expert investor and host of the BiggerPockets On The Market podcast. James calls this deal Humpty Dumpty because the property itself had a great fall, and it’s also a deal where he happened to lose $380,000.

David:
And I’ll say it again, being a strong real estate investor isn’t about never losing money, because that’s going to happen. It’s about being prepared so that when you do lose money, you bounce back, have strong fundamentals, know how to react, and have a plan to get yourself back in the game. Let’s get into it.

Rob:
So James, when did this deal happen and how experienced were you at the time?

James:
I would say I was very experienced. This deal happened in the last 24 months. I’ve been investing since 2005. One thing I can tell you is if you invest for a long period of time, you’re going to run into these deals more regularly than you want, but lots of practice before I got to this major loss. Mine was a $380,000 on my bank account loss. So it was not on paper. It was a real, real hit. And it was just a deal that we bought in 2019, and we finished it up in the worst time you could ever finish a deal in the last 10 years, in 2022, and it took a clip.

David:
All right, James, what kind of property was this?

James:
So it was just a single family, our bread and butter, single family fix-and-flip. It was a 2,000-square-foot house, major fixer, view property, great area, Seattle. But it’s what we do on the regular, buy a house, renovate it, and sell it for some money. It just went the wrong way this time.

Rob:
How’d you find it?

James:
We found it off-market. So this was actually a property that was listed on market for a couple different years, never sold. Sent out a mailing campaign, and the seller engaged with us, and we skirted it off-market, and we thought we got ourselves a home-run deal.

David:
All right. And how much did you pay for this house?

James:
So we paid $550,000 for it. And this is in a class A neighborhood of Seattle, and at the time, after the renovation, we felt very comfortable that we’d be able to sell it for 1.1 million, so a huge, huge spread on this deal.

Rob:
Okay. And what was the plan for this flip? BRRRR? Live-in flip?

James:
So it was a very, very heavy value add fix-and-flip property. It was a two bedroom, one bath, 1,500-square-foot house that we were going to add another 700 square feet into the basement. We were taking it all the way down to stud, rebuilding the whole house. Everything was getting done. We had a renovation cost of about $250,000 allocated for it, which is about 125 bucks a foot, and that’s pretty typical for us on that size renovation in Seattle.

David:
All right. And how far into this deal did you get before things went wrong?

James:
You know what? It took me about nine months before I realized how bad this deal was going to get, and the reason it took so long to know was in Seattle, part of these deals that can go really bad, it comes down to debt costs and it comes down to timing. Time kills all deals, whether you don’t make a decision or you do. And so we had bought this property, and in Seattle, when you’re doing a substantial renovation like that, you have to apply for permits, and these permits can take a long time before they get issued, which we had planned for, but we didn’t even start working on this property until seven months after we had purchased it.

Rob:
Wow. So was it just sitting like vacant that entire time?

James:
It was sitting vacant. We went through, we did our asbestos removal, our abatement, and our demo, and so we pulled a demo permit and did a couple other little permit items that we could pull over the counter as we were waiting for plan review from the city. So yeah, it’s a waiting game on these massive projects. You just kind of push it through, you can do what you can, and then you have to wait for that permit, which is not the fastest thing in a lot of metro markets.

Rob:
Right. And so it took about nine months to get that permit. That’s when your deal started going wrong. And that’s why the deal went wrong?

James:
Well, no. Then it started getting real wrong. So we got issued full building permits, engineered, we had it designed all by an architect, and we started getting into the framing on this house. So we had demoed it, and when we demoed it, we saw that there was some cracks and kind of sinking in the foundation that was a lot worse than we had thought. But I’ve done countless amounts of projects where we are repairing structural walls, foundations, and so for us, we brought out our foundation contractor, our structural engineer, and as we started demoing and framing the house, the house started shifting dramatically and it literally fell over like the Leaning… Or maybe another nickname for this is Leaning Tower of Leschi, because that was the neighborhood that that was in. The house, all of a sudden, went sideways on top of the hill, and we had to rush in with our foundation specialists. We jacked the house back up, re-poured a foundation wall, and got it stable.
So it was kind of like we dodged a bullet. But what had happened is we had full building permits, but we did not have a permit to jack the house up and re-pour a foundation wall. Now, we could have added that in if we knew we needed to do that in the original, but that’s a new permit at that point. So the neighbor was really concerned we were going to block the view when we jacked the house up. I met him there. I said, “Hey, just relax. It’s going back down. We have full building permits.” We went over the permits. He said, “Everything’s fine.” But then 24 hours kicked in and he freaked out again, called the city, city came out. They said, “This is outside your scope of work for your permit. You need to go back in for plan review,” which would’ve took another 9 to 10 months to reissue this permit. So then we would’ve been stuck on this house for 18 months, paying 12% interest in points to do the renovation.

Rob:
Dude, that’s wild. Genuinely, I’m not even kidding, my forehead hurts right now. Honestly, it’s coincidental, because it’s been hurting the last couple of days, but when you started telling me that, I was like, “Ow, it hurts.”

James:
Yeah. The pain just began to start at that point, Rob.

Rob:
Oh, really, there’s more?

James:
There’s always more.

Rob:
Yeah, just get us through this quick. Rip the bandaid off.

James:
So then we decided, “Hey, we got to rip the bandaid for real,” right? And we’re looking at our pro forma, because anytime you’re having a change in your plan, you need to reevaluate what you’re doing. And so at this point, we looked at what we’re doing. We knew we had to wait another nine months, we knew that the house value wasn’t going to shoot up dramatically, and that nine months of cost is going to be right around $100,000 for that house. It’s going to be about 80 grand. That was going to destroy our pro forma at that time, in addition to, we had an additional foundation cost. So we said, “Okay, our plan doesn’t look like it’s going to work well. We want to get through this deal, but we want to go to highest and best use. That’s what we’re always tracking.”
And so re-comp the property. We saw that new construction we’re selling for the high-2 millions to $3 million range, and we were on a prime street with a view, and that’s what sells, novelty sells. And so we decided, “Hey, if we got to wait nine months, then let’s just re-permit a new house instead of the house.” But we had already spent a hundred thousand dollars in jacking up this house, reframing it, siding it, windowing it, and roofing it, and so that was just dead cost. So our basis now went up by a hundred grand. We had nine months to sit there to get our first permit, and we had to wait another nine months. So this 550 purchase price just turned into about a 750 purchase price very, very quickly with debt costs and the money that we already spent on this property.
We get our permit, it gets issued, it takes us about 15 months to build this property, which is about three to four months longer than normal because we’re on a nasty slope with bad dirt, and we had to spend a substantial amount of money putting in our foundation, which we had accounted for, and we built one of the most beautiful homes that you can see, this really cool northwest modern, rooftop deck, concrete finishes. It was beautiful. But when you build a beautiful product, sometimes it doesn’t matter. And when we finally got to sell, we hit the worst possible market timing.
And the reason we missed the market timing is actually, let me take a step back. When we got the building permit issued after waiting 18 months, it was right in the rain season. You can’t put foundations in a rainy hillside that’s unstable during rain season, so we had to wait another four months before we could start the work. And because we had to wait that four months, it kicked the can down the road, and we listed right as interest rates started doubling rapidly, and our $3.1 million value got compressed by 15% very, very quickly because the market went into this quick free fall in Seattle, and we ended up selling it for 2.5 million. That’s $600,000 less than the comps were nine months prior for when we evaluated it.
Once you racked out all the purchase price, the bill costs, the debt costs, it ended up being a $380,000 hit. And not only that, what makes my skin boil on this deal even more is we had like $350,000 just sitting there for three years, not only not making money, but losing money that time, and the velocity of money and time value of money was just shot at that point. So it’s a $380,000 loss, but typically we make 20 to 30% on our money minimum for fix-and-flip on that point, so it’s really like we lost 6 to $700,000 with the time value of money, the loss of opportunity, and the nasty hit we took in getting in the red out the door.

Rob:
Okay, so let me ask a clarifying question here. Were you all in on this deal at 2.9, and so you sold that 2.6, and that’s how you lost your 380?

James:
Yes, yes. Because our debt costs, we had to hold cost this property for over 30 months. It’s basically 30 months, start to finish, right?

Rob:
You said an 8 to 10% interest rate?

James:
Yeah, it ended up being… So for the first 15 months or 14 months, we had flip debt, which was 12%, two points. When we went to issue a new building permit, we actually got our debt cost down to 6 1/2% with a new construction loan because we get really good friendly terms, but that’s a floating rate when you’re getting that kind of rate on a new construction.
So then in our pro forma, we had performed it all the way out at 6 1/2%, but by the time we were building it, we were up to 10% because the rates had jumped so dramatically. And so it was like an average cost of blend on there, but yeah, we had at least 250 to $300,000 in debt costs. We had a build cost of around, it cost us on average, usually we build a house for about 300 to 300 bucks a foot start to finish in Seattle, but when you’re on hillside, it costs a lot more, so we were about 400 bucks a foot for that build, which cost us about 1.25 on the build. So with all the debt costs, the build costs, and the cost of dirt and the waste of the renovation, we are into it for about, yeah, 2.6, 2.7 because we have about a 10% selling cost in Seattle.

Rob:
Wow. Okay. And so what did you learn, man? Because it seems like you learned a lot of things the hard way. Give us a couple of lessons from this deal.

James:
Well, you know, looking back, I don’t know if we did anything wrong. We were using stats and facts to make our decisions, and sometimes it’s just bad, bad market timing. What I would’ve definitely done wrong, and this is what we’re offering, especially on today’s market, we have a flatter market, it’s a little bit riskier, there’s not as much upside in them, it’s all about structuring your terms upfront right. So we knew going into this house that it was a nine-month permit with this owner. We should have offered to close on permits when our building permits were issued. We could have gave them large earnest money, we could have released it to them. That would’ve saved us about 100 to $110,000 in debt cost during that time, in addition to I wouldn’t have spent $100,000 on the renovation during that time as well.
And so it would’ve saved at least $100,000 right there, in addition to, if we wouldn’t have been in that deal and we got red-tagged and we had to put the foundation in, the $100,000 wouldn’t affect the performance so much. We could have stayed with our original plan and we could have tooken that plan all the way through. It would’ve probably still made us, even with the rates shooting up, $100,000 because that price point didn’t shift as much as the higher end. Around a million to a million-three in Seattle, it only came down 5 to 8% rapidly when the rate started jumping. The higher end dropped a lot quicker. And so if we would’ve stayed with our original plan, the loss of value would’ve been a lot less, we would’ve been in and out a lot quicker, and if we would’ve closed on permits, we could have done that all, but we just couldn’t absorb that debt cost.

David:
All right. So James, how has this deal helped you on future deals?

James:
Right now, what that told us was it was kind of the shift of… You know, every market’s different. Every market shift is going to teach you a different lesson. And what this was was the indicator for us that we need to switch our whole business model up for the next 24 to 36 months because we were officially in a shift of a market, right? We went from a razor-hot, high-appreciating market to an instantly declining flat market really quickly. In a flat market, it’s what it was in 2010 to 2014, you have to nail your construction plans and you have to stay inside that plan for you to make any money. There was no appreciation to save us. 2010 to 2014, it was execute the plan, make some money. If you don’t, you’re not going to make any.
And that was the sign that, hey, this is back to this market that we really got to get over, as we’re writing our offers, really think about the plan, structure your offer around the plan, not just the pro forma and what price you’re getting. And so it’s a shift in how we do business. We are not closing any properties on long permits as of right now. Now, we would’ve done it 36 months ago because the market was so red-hot and inventory was hard to find. You could factor in a little appreciation there and you knew it was going to rebound well. When you’re going in a flat, you got to execute well. And so everything that we’re closing on are long permits. Even this duplex I just bought recently, I closed with a long permit. They allowed me access beforehand. It allowed me to get cheaper financing. The cheaper debt and financing is making the deal a home run rather than a loser. So it’s really about structure for the next 12 to 24 months.

Rob:
And you’re not doing any long-term permitting stuff, you’re saying, because, yeah, the market, you just can’t really predict how crazy the market’s going to get in the next year, and so it’s just an overall risky play to have such a long timeline for some of these properties?

James:
We’re still doing it. Right now, we probably have like $6 million in land that we’re contracted on with long permit closes, but we’re contracted and not close, so the risk is, A, we only have to put up a little bit of earnest money, give it to the seller. That’s better than a down payment on a property. We get to keep our cash on hand right now as you’re kind of weathering through storms through your business and growing different departments. In addition to, we don’t have to rack that debt cost. Debt is expensive. There is no more 6, 7% hard money cost or lending costs. It’s 9 to 10%. So we can avoid that interest rate spread. And so we’re still doing them, but we’re not closing until the permits are issued or we can start our work today. We don’t want to start our work in nine months.

David:
That’s good stuff. So James, to recap yours, it sounds like time was the killer. The period that you don’t have any control over, when you’re waiting on the city to come back or you’re waiting on the weather to change, it was always something outside of your control that forced you to wait, where you just had to keep making those debt payments. And so what you learned about your deals was do as much as possible before the deal closes or structure this in a way that you limit your risk and your exposure to time that’s going to cost you money. James, anything you want to add?

James:
Yeah. Like a $380,000 loss, that can be detrimental. That’s a huge number on anybody. But the reason we could absorb that loss is because we had such a red-hot two years of flipping, where if we look at our three-year average of flipping properties, we absolutely crushed it. This was just how it ended, right? You can’t time the market perfectly every time. But the reason we could take that $380,000 loss is because we take 10% of our profits and we stick them over in a bucket because we know that there’s something coming at some point. Because even if you’re a really good investor, I always say you’re going to lose 1 out of 10. It’s just going to go wrong. And so you want to have that cash aside. We had just done really well on flipping. We had cash over here. We could absorb it.
And then we also didn’t let the fear of the loss trap us. Sometimes, like we could have refinanced this property and took a nasty loss every month trying to do a midterm rental, short-term rental, try to break even, but we wanted to get our cash back. Not only did we take the loss, we did get $200,000 of our own cash back to us, or 2 to 300,000. We put that money to work since taking that loss, and we have been making 30% returns on that money. We’ve turned that deal now twice, so we’ve already made back half of our loss in the last nine months by reinvesting it.
So don’t get locked up, don’t get afraid. You got to figure out how to rebound back out of it. If we would’ve just been like, “Hey, this isn’t for us right now,” it would’ve ended with a loss. Right now, we’ve already made traction on it. I bet you by the end of the 2024 or by the first quarter of 2024, I will have that loss redeemed. And so you’re going to take these as investors, but you’ve got to reposition, you got to reinvest, and you got to regrow. Things go up and down. Make sure you get it back up again.

David:
All right.
Thank you to all of the bigger losers on the panel today. It takes some guts to get up here and share your Ls, but we all benefit when it happens, so thank you a lot. If you’d like to get in touch with any of today’s panelists, including Rob or I, head over to the show notes and you can get our contact information as well as our social media. You can also find Mindy on the BiggerPockets Money show or James On The Markets BiggerPockets podcast, so check those out as well.
Any last words before we let you guys get out of here?

James:
Always be buying. Just buy your way out of it if you get yourself in trouble.

David:
Thanks a lot, everybody. We’ll see you on the next show.