Lessons learned from a JV flip gone wrong

[Micki M.]

...and still going wrong after 18 months...

Everyone talks about their real estate “education” which is generally an early deal gone wrong at a cost. My story is the same and I wanted to finally put it on the forums in hopes it will save someone else a similar headache.

This story is a prime example of letting dollar signs distract you from what your experience and instincts tell you. In fall 2013 I was wrapping up my most successful year yet as a real estate broker and finally had some cash to invest. Not much, but another broker had introduced me to an investor who pooled together assets to flip houses and I could get in for the low price of $10,000. I met with him and he seemed like a good guy, so I even arranged a meeting with a couple of friends, and we all signed up to do a project together.

MISTAKE #1: Referring friends to do business with someone before I had fully vetted them myself. I should have done a deal with him first or at least gotten references from more investors than one.

He sent us a prospectus for a house in South Chicago (don't say it). Purchase price $35k, rehab $40k, ARV $130k. I was set to make a sweet 30% return on my cash. And he said we would sell in 4 months. My broker's eye noticed two things. 1) We were buying one of the more expensive distressed homes and 2) the comps all had over 200 DOM, some as high as 500. I pointed out the comp issue to him, saying I thought it would take 6-12 months to sell, but I was okay with that.

MISTAKE #2: Even though I was okay with the sale taking longer, his estimation showed that he didn’t really know the market, and neither did I. That’s death to a flip.

He sent us each a JV agreement to sign. I was happy things were in writing and even had my lawyer review it, but I made…

MISTAKE #3: I didn’t listen to her advice when she pointed out issues with exit strategies etc because I was confident we’d never get to that point.

18 months later, yes 18, the house has not sold due to a variety of reasons.

- construction was severely delayed due to our first contractor walking with his deposit and then the polar vortex of spring 2014
- the realtor the investor chose wasn’t located in our neighborhood and wasn’t doing his job (our new realtor told us she could never show the house because the alarm codes didn’t work, something no one was aware of)
- hideous photos being used, and a complete unwillingness by the investor to get better ones.
- the property not being properly looked after resulting in a broken furnace this winter which of course led to burst pipes. My latest understanding is that there is an active leak which requires the city to shut off the water in order to repair and no one seems to know how to make that happen

MISTAKE #4: Trusting the investor to manage the project effectively from day 1 through closing without asking how that would be done. I have taken on the job of managing him which has resulted in some improvement in our awareness of issues but not getting them resolved.

I should mention that he has done no proper financial reporting and only gives updates when we bug him. We now cc everyone on communication which makes him work a little harder. I even offered to put together spreadsheets of expenses and sent samples I've received from other JV partners but he has no interest in improving his communications.

MISTAKE #5: Not clarifying how reporting would be done and what level of information was expected.

After gaining more knowledge and experience I can't believe I ever agreed to do this deal. I recently reviewed the JV agreement and realized…

MISTAKE #6: Not putting safeguards and penalties in place for non-performance. Since we did it as a JV, he got to use our money for free with no penalty for delays or mis-management. I would rather have seen the money convert to a loan or have interest payments after a certain point.

The investors got together and decided to make him an offer. He could cash us out at our original investment value and keep any profit made from the sale if/when the property sold. He seemed agreeable and we took the property off the market so he could refi. Turns out, he couldn’t qualify for the refi.

MISTAKE #7: Doing business with someone who has no alternative exit strategy or capability to carry financing. He did try to rent the property at one point, but didn’t consult us and was unable to get a tenant in place.

The one thing I did right was when I wrote the $10,000 check I knew I might not see that money again and even though it was a stretch at the time I felt I could afford to lose it if things didn’t go well. I’d still like to see it returned, but knowing other people’s stories I feel I got off relatively cheap for my real estate education.

I took that sense of “I can do this better” and put it to work. I am wrapping up my first flip this month. I’ll post that as a success story.

What I hope to pass on is: when you get excited about that first deal, especially when you need the cash and those big returns, don’t forget to do your due diligence and listen to your instincts. Run it by more experienced investors, ask for references, trust but verify everything. There will always be other deals, and while you have to jump in sometime, avoid the ones that feel “iffy” and make sure you can afford to make a mistake. 

[Will Barnard]

Great lessons to be learned here from your mistakes, not only you, but the readers too! The key takeaways should be:

1. A solid JV agreement written or at minimum, edited and approved by your attorney is NECESSARY. Legal zoom won't do it for you!

2. Vet your potential,partner or partners and make sure they have the experience, track record, and enough financial capabilities in the event of problems.

3. Know the area in which you are investing, know the market conditions, and know the alternative strategies before investing there.

Do these 3 things and avoid much of the problems shown in this thread.