How to protect your investment when buying complicated properties

In my last blog entry I spoke about special conditions that are sometimes tied to a property.

Most investors will be scared and so should you as this makes the investment a bigger risk due to the project being delayed or unable to obtain the necessary approvals.

There are ways to protect the investment where the only thing lost is time. Time can never be recuperated but at least you are not left with a property that is unbuildable or able to expand to meet the ROI. When putting in an offer on these types of investment there are a few ways to structure the purchasing agreement. I am no real estate expert or lawyer but this is from experience.

Require that the contract is contingent on obtaining an approval from the municipality. The vacant lot I purchased required a special exception. Before entering into an agreement I had met with the city staff (include the bosses) and they were on my side that I had a valid argument that the lot was buildable. I entered into the contract with the condition that the city would approve the special exception. The owner and I agreed on a five month period that I had to obtain the special exception. This gave me time to draw the plans, hire a civil engineer, submit the plans to the city and have both the planning commission and city council approve the plans. I had about 10 days left when the city council (last step) approved the special exception. Once this was obtain the contract became just like any other purchase and we had a month to close.

If I had not obtained the special exception I would have lost my time and about $5k in consultant and city fees. However, if I did not insist on the condition of approval and did not obtain a special exception I would have been left with a $230k vacant lot that was not buildable.

Another strategy which may be used along with a contingent is the right of first refusal. This would be done in cooperation with a contingent if the property requires special permits (I forgot to try this on my purchase). The offer of first refusal is where an investor usually offers a low bid to a Seller who has been sitting on the property for a while or there are complications like obtaining special permits. The Seller might not want to accept the bid since it is so low and something better may be around the corner. However, with the right of first refusal both the Investor and Seller are somewhat protected.

Here is a scenario. The Seller has the property listed at $500k. This has already come down from $700k and there has been 6 months with no interest from investors due to special permits required. Investor A offers the Seller $300k with the right of first refusal. The Seller accepts this offer knowing that investor A will take four months to obtain the required approvals. During these four months the seller may still list their property looking for a better offer. After two months Investor B offers $400k to the Seller. Before the Seller accepts the offer they have to inform Investor A if they would like to match the offer.

Investor A has two options. They agree to match the new offer (knowing that the ROI still works) and now the contract is worth $400k contingent on obtaining approvals. The Seller has now made more money without wasting time. Investor A still has a profitable investment and is two months into the process.

The other option for Investor A is if they believes that the ROI no longer works then they may pass on matching the offer. They will have lost their time and any money put into obtaining the special approvals. However that is only a few thousand dollars compared to a property that could be worth nothing. At this point the Seller may enter into a contract with Investor B for the new amount or stay with Investor A knowing that they are close to obtaining an approval. Once again the Seller either makes more money or they don’t waste anymore time.

The downside for the seller is if there are no new bidders. They then have to sell the property for a lower price than they wanted. However they no longer have to worry about selling the property.

Contingencies and the right of first refusals will work on properties that are complicated due to various reasons. On multi-million dollar deals these are the norm.

It never hurts to ask if a Seller will accept these conditions. It is vital to protect yourself if a permit is not obtain for properties that require additional approvals to meet the ROI. Always protect the investment. Always ask.