What lessons should I learn from this failed deal?

Question

I'm brand new to real estate investing. With my first deal I tried to hit a home run and I ended up striking out. In order to make the most from this failure I would like feedback on what I did wrong, and if my conclusions are reasonable. These properties are still for sale. I'm not linking directly to the properties because I'm going to quote their response to my offer, and I don't want them to feel like I'm singling them out.  If anyone wants the contact info for the seller's agent I'd be happy to give them that information via a private message. Also to be clear I'm not asking for a partner on this deal, nor do I have any connection with the seller apart from pitching them a deal that was rejected.

The deal was for two car washes being sold by the same investor(s) that were on the market for over 2 months. The first car wash was listed at $495k with a NOI of ~$56k. The second car wash was listed at $695k with a NOI of ~$100k. I looked at those cap rates was excited, but I knew that ~$50k cash, and ~$25k home equity wouldn't cover a down payment. My thought was to offer $1M for both properties so I could put 5% down, and ask the seller to carry $200k at 8%. This would bring them close to asking price (counting interest + the fuzzy math of potential capital gains savings), and hopefully make the deal attractive enough so a bank would lend me $750k. Below is my letter of intent:

• 1.Purchase Price

• 2.Definitive Agreement

• 3.Closing Date

• 4.Training Time

• 5.Nonbinding

This was their response:

My big takeaways from this experience are:

• Don't assume a property owner is distressed just because the cap rate is 2x the norm of other commercial real estate in the area.
• While reducing taxes might be a selling point in some residential deals, leading with this to commercial investors is a turn off.
• Limit training time requests to the absolute minimum. My current mindset of 80 hours = 2 weeks of work isn't valid for people with a passive income mindset. Also people who sell properties aren't going to want to be involved in the property for an extended time. Even if it is just a short phone call for general guidance in case something major happens during business hours in your mind, the seller may interpret this as me asking them to drive to a location at all hours of the night.
• Before submitting an offer I need to make every effort to learn as much about the motivation behind the sale as possible before making an offer. Otherwise I may alienate the seller with an incorrect assumption.

What do you think I should also takeaway from this experience? What do you think I learned that was incorrect?

Daniel Chang · Answer

Thanks for sharing this.

1) When you say the cap rate is 2x the norm of other commercial RE, do you mean car washes?  Or all commercial real estate?  Buying a car wash is more like buying a business with a real estate component attached.  You need to compare apples to apples, meaning what is the cap rate of other car washes that have sold.

2) Everyone wants to reduce tax.  Your mistake was that commercial owners are a bit more sophisticated than residential owners.  Honestly, your fuzzy math of how you almost arrived at their asking price made me cringe a bit.  If I was a seller, I'd be a bit insulted as well.  As in, "is he trying to pull one over on me?"  By doing what you did, you did not take into various factors including opportunity cost and time value of money that works against the seller, but somehow lumped all future interest and tax savings into the present value.

3) I thought your request of training for "next 2 years" was a bit much.

Ned Carey · Answer

@Erik Bollinger  Your last point about learning about the sellers situation is the most important in any negotiation.

I would also add real estate is a numbers game. More offers equals more deals accepted. Substantially better than average deals means substantially more offers required.

Great deals come from motivated sellers. These guys clearly are not motivated.

This is a very good return in today's market. There is probably more to the deal than you are seeing.

If the deal really is that good then why didn't you offer more than they asked for? Offer 1.4 million and they finance $300K. Bank finances $1,050.000. You put up $50K

Don't expect someone selling a business to help train you. Although that can and does happen) That is usually why they want out, they are tired of the business. You could have offered to work for them for two months prior to closing and gotten the same amount of training.

Ash Patel · Answer

I love @Ned Carey's advice about working for free prior to close.

Sharing that this is your first deal and ticket out of your 9-5 would raise questions about whether you will be able to get financing or not?  Speaking of which, have you spoken to a few lenders prior to making this offer?  You do know that car washes are not very passive, especially in climates like yours where you have to prepare for sub freezing temps.

Good luck and I admire your willingness to learn and solicit feedback.  I believe you will be quite successful!

Michael Boyer · Answer

While I know nothing about the particular business (car washes), it looks like you made a bold step into a new business with a carefully considered first offer.

I was not clear if you had the bank financing lined up before hand (which could have been key). That would seem to have been a convincing step to make the deal a reality. I might start there and develop a good commercial banking relationship.

Sounds like the seller wants the money to reinvest, so getting paid most of the purchase price at closing seems key. Now you know that. And I agree some preliminary recon work might have helped there, though some sellers are tight lipped.

The other biggest stumbling block here may just be not having a motivated seller. A more motivated seller may have countered. But, again, something like a financing contingency could have turned them off. They may not have wanted to get too involved if the financing was not in place, along with the other training and financing items.

It was not a clean offer per se but had some potentially messy details.

That said, I like all the takeaways you have gained and those of the comments that follow.

One addition, may be to really bone up on the granular details of the business and the particular locations.

For example, I think a negotiation practice (see the book Getting to Yes, etc) where you could point to some objective data that justified your terms, such as the price reduction, (like the market sales of similar enterprises, some deferred capital expenses, needed upgrades, etc) might have strengthened the offer. Or simply showing how the numbers had to work for you with your financing.

As for now, they know you are an interested (and thoughtful) buyer and I would just wait. Your bait is in the water. Who knows, the seller may not get a better offer (or any offer) and call you back in a year or two. Or if you get more definitive financing terms, you could always look at the deal(s) again. I think their long response shows some interest and could guide you towards how you might craft a future offer more appealing to that seller.

Best of luck.

Ned Carey · Answer

@Erik Bollinger

That is how I got good at doing deals. I wasn't smart enough to evaluate a "typical" deal. I only did what I thought were home runs, so that if I was wrong, I had a cushion.

Ultimately in RE you market knowledge and ability to evaluate deals will get better over time and you can make more reasonable offers. In the case of buying a business, you  need an education in that business also. In the short run there is nothing wrong with playing it safe.

You really did nothing wrong here. The fact that you are taking time time to learn from it is an excellent predictor of future success.

Levi T. · Answer

What everyone else has said is on point. You need to understand, that you need to start with "hello" and not just lay down  the tracks from start to finish in one go, before ever saying hello how are you. All my deals start with expressed interest in the business or property, then I ask why are they selling, how's business been, and slowly you dig into the art of making a good deal, a price range, a price, downpayment amount, if any, then ask about training (yes ask, if they set no, you say no problem), etc, etc. All the way to the contract finish line . It's a tango!

Erik Bollinger · Answer

Please let me know if I should fork this and post it as a new thread.

It seems like a couple of people have said that I should have gotten sign off by a lender prior to submitting my offer to the seller. I know when I purchased my residence I went to a mortgage broker to get prequalified for a loan based on my credit score, assets, and income. I thought commercial real estate was different than residential because the loans are generally bigger than people can pay for without the income from the asset being acquired so the asset in question and the terms of the deal were crucial to getting financing. My belief was that commercial bankers wouldn't waste their time talking to every person holding a real estate listing, so I would need to have a deal in hand for them to take me seriously not just a report outlining a potential deal.

Are those beliefs flawed? Should I have gone to banks with the listings and my research prior to making an offer, and talk with the bank prior to accepting/posing a counter-offer? Or should I go to banks even earlier, and say something along the lines of "According to your website you state you do XYZ commercial loans for ABC reasons. I'm a new investor interested in commercial real estate. Would you be interested in working with me and what kinds of numbers are you looking for?"

Joel Owens · Answer

Don't buy into a bad deal just because it is your first deal.

The better deals are generally given to experienced buyers because the sellers know they can sell quick and the deal will close.

Newbie buyers that are under capitalized for what they want to buy tend to offer wacky strategies to make a deal work. That requires a lender and the seller to take a chance on the buyer.

I have clients that buy commercial retail for the first time and I have to educate them but they are buying 3,5,10 million properties and up and have substantial net worth from their corporate jobs, businesses, stocks, inheritance, etc.

Ned Carey · Answer

@Erik Bollinger don't rule out the capital gains discussion in negotiations. Just use it when it is appropriate. Which goes back to our own point of knowing the sellers wants and needs.

What lessons should I learn from this failed deal?

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