This past week, one of my investing partnerships and I had to cancel a purchase contract on a 20-unit apartment complex.
We thought we had a smoking-deal. And based upon what was provided in the listing and surface-level financials, we did. Agreed upon purchase price was close to $1,000,000.
But as we dug deeper into the details, several irregularities surfaced, including the following:
- Financing Parameters Were Off. Our lenders would only lend 50-60% loan-to-value for this particular property. Normally, we would get 70-75% LTV. So, of course our projected cash-on-cash ROI was no longer attractive.
- Pro-Forma Was Off. In reviewing the seller’s pro-forma, he eliminated 90% of his actual expenses that we uncovered during due diligence. The Seller must have liked the fantasy idea that expenses would be significantly less in the future. Depending upon the age of the property, a good rule of thumb for most apartment complexes should show and budget/forecast 50% of revenues going towards expenses.
- Seller’s Story Was Off. The seller/owner was paying salaries to unknown sources for unknown reasons out of the cashflows of the company, and claiming these sources as owner-benefit cashflows. Normally astute investors convert earned income into passive real estate income, for tax-benefit reasons, but here, they claimed to be doing the opposite, by converting passive income into earned income, which of course made no sense. When asked to disclose bank statements and tax returns to validate their story, they refused. Huge red flag.
For all the above reasons, we passed on this apartment complex, and are back to actively looking for our next investment property.
Key points from this post:
- Never fall in love with a deal.
- Always do your due diligence.
- Involve your lenders and partners in the details from the get-go.
- Recreate your own reality-based forecast – do not use the selling-broker’s pro-forma.
- If the Seller will not disclose, you must assume the worst.
- If it smells like a fish, it’s probably a fish.
