When we jumped into investing at the end of 2020 the market was already off the rails. Home prices were too high, labor and material prices were too high, inventory and availability were both too low. I spoke to a dozen or so experienced real estate investors who all said the same thing – this is a horrible time to invest. So we did what anyone would do and jumped right in.
Quickly, we learned that because inventory was so low, every deal that we found also had dozens (at least) of other investors lurking as well. If we wanted to be competitive, we’d need to find a way to present the best offers. Now, you can basically negotiate anything you want into a contract but some of the key items are price, closing times, and (drumroll please) contingencies. A few of the big contingencies are financing contingency and home inspection contingency. Those allow a prospective buyer to walk away from a deal within a specific timeframe if the financing falls through or they discover something about the property they don’t like. Now, if you waive those (or other) contingencies, you’re basically giving assurance to the seller that there’s a higher likelihood you’ll close the deal and buy the property. If you don’t, you’ll lose your earnest money deposit so there’s something in it for the seller no matter what.
To jump ahead, we put offers on thirty or so properties before getting one accepted. The one that got accepted? Yep, we waived our inspection contingency. Why did we do that? Well, first, the listing agent was clear that the sale was as-in, meaning that the seller wouldn’t fix anything that came up in the home inspection. Secondly, we had access to all the units (this property is a 3-unit MFR) so we could assess the property condition and even talk with the tenants about their experiences. Finally, we were securing conventional financing for the purchase, which meant that the bank would separately appraise the property and make a determination about whether or not it would lend on it and banks typically won’t lend on a property that needs a bunch of work. The intersection of those three things gave us enough peace of mind to waive the inspection in an effort to make a more competitive bid.
So, that’s how it started. How’s it going? I’ll start by saying (especially to new investors) do NOT waive your home inspection. Here’s what we learned.
- Just because the sale is as-is, doesn’t mean you want to (or are able to) address issues with the property. In our case, there were no big structural issues, but we learned after closing that the prior owner had rigged the utilities to steal from the power company. In a stunning twist, the power company came after us for stealing power once we alerted them to the issue – threatening to shut off power. The listing and contract represented the property as having separate utilities in all units. As we walked the property we verified separate meters but never could have guessed at what the prior owner had done to rig the place. The tenants were also paying each other to split expenses. What?! I thought you said you spoke to the tenants before you bought the place?! We did – the human condition is a funny thing…
- People say the darndest things (or don’t). 24 hours after closing on the property, we got our first call from a tenant who asked to have someone come look at his stove. He said that 3 of the 4 burners didn’t work and the oven did work. Oh, and he also said they hadn’t worked in about a year and a half, and he’d asked the prior owner repeatedly but nothing was ever done. About 2 days later another tenant called to ask if they should continue to pay one of the other tenants for their share of the utilities or would we be fixing it so they paid the utility company directly? It appears as though the prior owner had been double dipping on collecting money and pocketing the difference between what he’d collected and what he owed the utility company. From there, the stream of issues and concerns about the prior owner from our tenants flooded out with force…If I had to guess, when we asked, they painted a really rosy picture because they genuinely wanted him to sell the place. There are two sides to every story, but they’ve painted a pretty poor picture of the prior owner…They weren’t going to tell us the issues when we were buying – that might have scared us away!
- Banks, or mortgage brokers, have a way to present data to make things go their way. In this example, we bought a property that’s a B-minus property in a B-minus area. With the market as crazy as it has been, even the value of C properties in C areas seem off the charts, so our had no problem appraising above the amount of our loan – which has a lot to do with value relative to similar places, but much less to do with specific work needing to be done on our property. In addition, we represented a fairly low-risk profile for lending, so the lender was going to find a way to make it happen – that’s literally how they make their money, but it’s not at all a substitute for a good home inspection.
Going into this and any deal, we include some rehab to stabilize and make a place rent-ready. In addition, we have access to additional capital to make sure surprises are not the end of the world. Unfortunately, we got some surprises on our first two deals, but we planned for this scenario and learned a valuable lesson about the risks in carving out an important part of due diligence. It’ll be a while before we waive the inspection contingency again – even if that means missing out on a few deals along the way.
