Our Company's $40,000 Mistake

Our Company's $40,000 Mistake

We all make mistakes as humans. The best way to avoid them is to learn from others'. Read on to learn from mine.

Jack Gibson

I’d love to share how I always make great choices and follow my own advice.

But alas, I’m only human - full of errors and bad decisions.

So today, I’m going to get a bit vulnerable and share a recent setback.

My company, High Return Real Estate, is going through an aggressive growth mode. We have been purchasing multiple properties ever since the Fed started hiking rates and slowing the housing market.

This is exactly what we’ve been waiting for. This is a real estate investor’s time to make moves.

With over 15 new acquisitions, we were looking to hire a construction manager to hire new crews, put the crews in their strength zone on projects suited to their strengths, and double-check their work.

My partner, Shecky, had a relationship with a guy going back quite a few years, so we brought him on a Zoom interview. He would be making a big leap of faith if he took the position, which would require a move across the country from Idaho.

We ended up hiring him, and we spent $10,000 just to move him. We gave him four projects and $40,000 in capital to buy materials and hire crews.

As we let him loose on the projects, some things started surfacing that weren’t so great. He worked very slowly, had some anger issues, and then kept complaining that he didn’t have enough funds to pay his crew.

But I suspected that he spent the money on his personal bills - I know it sounds like a dramatic twist to the story.

And when confronted, sure did he admit that he used the $40,000 to pay off his debts. His defense was, “I didn’t misappropriate the funds because I can work it off in labor.”

I lost my cool. Luckily for him, I didn’t get to fully express my thoughts - I got an urgent text message that I was needed by my wife. Apparently the smoothie shop she ran had a rush and she had a line out the door.

To make matters worse, some things came to light about his past that revealed some very poor character. Now, I’m not one to judge or condemn because I believe that people can change and overcome their past, but had we known what we now knew, we would have been a lot more careful and dug a lot deeper in the interview process.

After giving him a couple of months to work off the debts in labor, we just found it too disruptive and distracting from our focus. So last week we fired him, and told him to let his conscience be his guide to paying us back.

That felt a lot like Lloyd Christmas from Dumb & Dumber (Jim Carey’s character) telling us, “That’s as good as money sir. Those are IOUs. Go ahead and add it up. Every cent’s accounted for. Look, see this one. That’s a car. 275 thou. Might want to hang on to that one.”

We got about $10,000 worth of work from him which knocked the $50k down to $40k. Then we capitulated, and decided he was too much to deal with. (I’ve been hearing the word “Capitulate” a lot recently, so I thought I’d try it out. I like it!)

That’s the thing about business, right?

We are going to make mistakes. We are going to partner with the wrong people. We are going to make investments that appear to be strong, but then for one reason or another they go bad.

The one mammoth mistake that I made, however, was not following my own advice.

Why My Gut Knew Best

In my book, “Building Indestructible Wealth”, I tell the story of how you should get background checks on people you are going to need to put your trust in. I’d gotten burned in the past by being overly trusting, so I urged my readers to take the extra step and get a background check to see if you’re dealing with a frog or a scorpion.

Here’s exactly what I said on pg. 130:

“Another lesson I learned is that when dealing with people you don’t intimately know, like, and trust, you can avoid a lot of pain from verification. None of us ordered a background check. None of us ordered inspections.”

I don’t think background checks are needed in most of life’s situations. Typically the amounts and length of the partnership are too small and make it too cumbersome. But when dealing with larger amounts with someone you haven’t known intimately for several years, background-check them without hesitation. Meet people they know, interact with their previous recruiters, have a chat with their ex-colleagues, and get to know their true work ethic and mindset. It isn’t going behind their back; it’s just being cautious.

Because you don’t really get to know someone’s true colors until about a year.  

Why didn’t I follow my own advice?

I’m not exactly sure. I probably got busy and said to myself, “Shecky’s known this guy for several years, so he has to be fine.” The problem is, Shecky didn’t know him beyond a casual acquaintance, and could not have known what he was, or wasn’t, made of. This doesn’t mean that my trust in Shecky’s decisions is altered even by a bit. Again, it’s all about caution.

Now, I realize this is not immediately actionable advice. I bet no one reading this needs to run out and get a background check on someone they are going to do business with. But file this one away, as you’ll surely need it in the future. And I bet it’s going to save you a lot of headache.

I do have some actionable advice to offer, though.

So What Can You Do?

If you’re interested in getting into real estate, this is one of those risks that you have to deal with. There are 3 main obstacles that investors have to navigate:

  1. Property
  2. Contractors
  3. Property Management

Our company has done over 300 deals, and since no deal can be perfect, we’ve experienced losses from all these three risks. This is to tell you that I speak from experience.

This is why I adamantly tell anyone who will listen to buy investments to have much of the risk removed. You want to protect that initial capital, especially that first $100k. It’s just too painful to take a big hit on that first set of capital.

3 Major Risks To Buying Real Estate:

1. Paying too much for the property condition

When I first started in real estate, I didn’t bother to order inspections. One of my first real estate deals was an 8-unit small apartment complex. The cash on cash returns were off the charts. Based on the profit-and-loss statements the seller sent me, I was walking into a cash cow. The property manager said that nothing was really wrong with the property, so I took his word and passed on the inspection.

That place was a total money pit, and for the next two years not only all the rents I received went right back into the property, but I had to come out of pocket as well. It’s the worst feeling to buy a property that looks good on paper but in actuality is a repair nightmare.

New investors get like a kid in a candy store with like 5 bucks in his pocket. They literally cannot wait to part with their cash. The only thing they do is sit back, relax and look at a lot of deals. But nobody learns anything on how to evaluate whether you’ve got a good or bad deal from reading a book or listening to a podcast. You’re gonna have to analyze and run numbers and if you know anyone with experience that you can run deals by, by all means do it.

2. Getting screwed by contractors

When you buy rental property, the best deals almost always need some work. If they were in immaculate condition, then those are going to get full retail price. At least you won’t be getting any sort of steep discount. That’s because most retail home buyers are not looking for a fixer-upper; they want something that looks nice and finished and move-in-ready.

This is also the most competitive buyers pool, as they aren’t thinking in the same terms of an investor who’s purely running numbers. The home buyer falls in love with an area, and then a certain house, and once they’ve found what they want, the numbers aren’t as important. No wonder we observed regular-looking houses in the market getting 12 to 20 offers within just 72 hours of opening during the crazy COVID era.

The houses that need a lot of work have a much smaller buyer pool, because they won’t qualify for financing in their current condition. So you are only competing with a much smaller pool of mainly investor cash buyers.

I’d love to say that contractors are always honest and fair and do everything they’re paid to do, but that’s merely utopian.

When you come to companies like us with your real estate project, part of the problem for us that you won’t encounter is the sheer volume of work we’ve had to complete. There were times where we had 20-odd projects going at the same time, so we needed to tap multiple contractors. Now comes in the worst friction-factor: Shoddy work. We made the mistake of paying incompetent contractors who simply took the path of least resistance - they did only half the job.

This was worse than simply stealing the money, because now, we had half-dug up walls and ruined demo items to replace!

Here’s the lesson: When you’re doing a higher-end retail finish, you’re likely to go with a reputable contractor who’s also pretty expensive because of their reputation. When you’re good and honest, you’re going to get paid very well. On investment rental properties, going with a high-end expensive contractor often doesn’t work simply because the numbers don’t work. You’ll need a mid-range pricing to get the profit margins or equity to be in the deal right.

3. Uncertainty with property management

In business, a team creates success. A great team can take an average product and turn it into a profitable business. Conversely, a poor team can take a great product and turn it into a cash flow disaster.

The profitability of your property largely hinges on the property management team you partner with. Property management can make or break your investment. Your team has got to advertise and screen tenants, coordinate repairs and maintenance, bring in contractors, and often get multiple bids to ensure you’re getting the best price.

Unfortunately, I’d partnered up with some real losers. The property manager on the 8-unit apartment complex ended up stealing from me and neglecting some repairs that were dangerous to the tenants.  His wife was battling cancer, so I believe he stole the funds to take care of his wife, which makes it a little less painful, but regardless no one likes to deal with theft in any circumstances.

I had another property manager pay out fake rents and was running a Ponzi scheme to lure investors to buy more properties.

But just like everything in life, I’ve had some fantastic property managers that have helped me make a lot of money.

I don’t want this to scare you away from buying property. Rental property has helped me get into the game, make some great money, and then trade those up for even bigger, better deals. I want to help you avoid some potentially extremely costly mistakes. I’ve made all of these mistakes, and I’ve still made over $2 million in real estate.

Mistakes are inevitable. All we can do is mitigate those and prevent them from digging a financial hole you can’t get out of for several years.

How Do You Completely Avoid Mistakes?

If you want to bypass any of these mistakes and not take any chances, then consider buying a turnkey property.

I ended up buying turnkey, because after quite a bit of research and looking at deals, I realized three things:

1) I was getting distracted from my primary business, which was clearly becoming costly to the growth of my main asset.

2) There was so much I didn’t know, and plenty that I didn’t know that I didn’t know. As Jim Rohn says, “What you don’t know will cost you.”

3) I couldn’t find any deals that made sense in my local area. When I heard the saying, “Live where you want to live, but invest where it makes sense,” I had a massive mindset shift, and started looking at other more profitable rental markets across the country.

I started buying up turnkey properties in Indianapolis, ranked consistently in the top five cash flow markets in the US. My first year, I generated $75,000 in rental income. The turnkey provider turned out to be shady, so I started my own company in 2016. We’ve sold over 300 properties to investors, and we’ve developed a great network of partners in multiple markets that help investors find quality turnkey properties with great management teams in markets such as Birmingham, Memphis, St. Louis, and Chattanooga.

If you’d like more information, book a call with Nicole, our head of Investor Relations at www.highreturnrealestate.com/cashflow. Or you can email her directly at nicole@highreturnrealestate.com.

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