How to Deal With Problems in Real Estate Investing

Today I want to go over things that every single real estate investor is going through on a daily, weekly, monthly basis, but people don't talk about, and that is problems that show up that we need to overcome, that were not part of the plan. We all have had hard days. I was crying the other day for buying a particular asset class. We are talking with our friend, Loe Hornbuckle, he posted something on Facebook the other day about a significant problem that him and his partners had to overcome over the last several months. And I thought it would be a great idea to share that with everybody so that when you are dealing with something, you can start thinking outside of the box and figure out how to solve the problem.

Tell us a little bit about you.
I live in Dallas and myself and some others in our group are involved in two primary asset classes, we focus on boutique assisted living and memory care, we build and develop those. And of course, we also do build to rent projects. So we develop townhouses, duplexes that we rent out and manage like a traditional multifamily. I, personally have a few hobbies, I play poker, and I'm into long range shooting.

Tell us what your project was about. What were the initial goals, your timelines, and your fundraising target?
I find that sometimes, and I'm sure you probably noticed this too, that social media can be a highlight reel, nobody really talks about the stuff they deal with. And I've always just tried to be myself. I thought there were some interesting lessons from this particular project. We had an opportunity to develop a 99 unit townhouse project that was going to be a build to rent project, and we were going to do so in phases. We were going to do 30 units per phase, and three phases. And the thing that we were first considering is, should we self fund this, or should we put this out to investors? The next thing that happened is, as we were in the process of wrapping up the deal, we started to notice that we were struggling with people backing out of pledge commitments in a way that has never happened before.

This happened in late January to the middle part of February. It was the time when America was waking up to COVID and what's that going to mean, and what's going to happen. To compound matters, this is an opportunity zone deal. So a significant portion of our investors were opting to defer capital gains from things like the stock market. And of course, the week that we went to close the deal was the famous worst week in the history of the stock market where it dropped 20% in a couple of days. So the world is chaotic, we don't know what's going to be happening. And we're in the middle of trying to close this transaction. The total equity raise was about $3 million, the total project was about $18 million. Because we were doing the construction and phasing, we had pretty favorable terms from the lender, having had a track record with that lender, and it was also an extension of an existing project. We had a 60 unit project next door, we bought the adjacent land, and from the bank's perspective, we had already successfully done a deal with him before, it was really just an extension of our business. So we really got very favorable terms from a great local lender. So that's the backdrop of the deal in the situation.

That sounds like an incredible project, and then COVID hit. This can be something that can happen at any point in time in different types of versions. It can be the economy or anything else. So this one was COVID. How did you guys overcome this problem?
I don't think I'll ever forget this, because how many people can claim that they closed a major real estate transaction on the day the President of the United States put the United States in a state of national emergency? Literally, the day we are closing on the deal, the President's on TV saying we're entering a state of national emergency and, like a lot of people, you're in California, you have earthquakes, you have fires, there are all kinds of city and state emergencies, but I've never seen a national emergency before. So I didn't know what that meant, or what was going on. All I know, is that I closed a very large real estate transaction, by some standard, $18 million is pretty large, on the day that the president is on TV, basically saying the sky is falling. So that was very fun.

I think the thing to understand is that because our construction was being done in phasing, we went ahead and figured out what our three targets were, what we needed at a minimum to close the deal in terms of investor equity. Then the second question was, what do we need to do phases one and two? And the next question was, what do we need to do all three phases? So we broke the project up into a few different metrics When you're doing a raise, people always focus on the ceiling, how much money you're going to raise. But the question that we asked ourselves was, what's the minimum amount of money that we can raise in order to not have the project be delayed? And so we came up with those three numbers. And coming off a successful raise for the assisted living project next door, we thought it was going to be very simple. We just closed another project about a month earlier and it was a bigger raise. But obviously, the world changed a lot in those 30-45 days. And we started to notice that even though we had the deal fully pledged, that about 30% of the people that had pledged, pulled out for various reasons. Whether it be fear of the unknown, whether it be, Hey, I was going to put my stock market gains into the deal and I no longer have stock market gains, those types of things. So there was a lot have different reasons and we were noticing a tremendous amount of attrition.

I think the element that probably became interesting to you, that resonated with the idea was, whenever you're having a project that isn't being as successful as you want it to, you get all these pledges and they back out, you have a couple of choices. And one of those choices for some people is, Okay, we'll just go out there and sell the project. And there's a lot of people that sort of think that's the correct strategy. And I don't particularly think that was the correct strategy on this deal. There's certainly a time in my life when I would have done that. I don't begrudge anybody that does. But the second alternative for us was, this is maybe the worst time to be closing a deal imaginable, in our lifetimes anyway.

So we just said, Listen, why don't we look at how much money we raised? And is that enough to hit our floor? And fortunately for us, not only it was enough to hit our floor, but we also could do the second phase of the construction as well, it was going to be very tight, but we were right there. We were still about a million dollars short, and our philosophy turned into, instead of being hunters trying to figure out where to sell this thing, why don't we just pull it off the table? If somebody asks about it, we'll discuss it with them. But we're not going to discuss it as though we're actively raising money. If someone asks us if we're actually raising money, our answer is not really. And we decided to do that because we figured there are going to be better days, there will be be days coming along where someone will be interested in the project.

Additionally, since we can do the first couple of phases without raising additional money, the timeline meant that we didn't really need the additional money for a year, maybe two years. We weren't really in a hurry. I think the first thing that I think we were happy that we did was that we were smart to set a floor. Sometimes when people were doing their operating agreements, they don't ask those questions, they just assume the raise is going to be successful. And so they don't set a floor. For example, if you're doing a $3 million raise, and you can close the deal with $2.8 million, then as long as you get 2.8, you can close the deal. In our case, that number $2 million. So that was the first thing we helped ourselves with, we didn't know this was going to happen, but thinking through the things that can happen. Putting that in the operating agreement to the investor certainly was to our benefit.

And then the second thing was being patient, having the ability to say, There are going to be better days ahead. Arguably, there could be even darker days ahead, too. But I think a lot of the fear in the investment community, in the stock market, whether you think it should be worth what it's worth now, is certainly stabilized and hit new all time highs. And so trying to invest in an opportunity zone deal at the worst possible time for the market was just a timing issue. And because we thought the project wasn't flawed, we didn't think anything had changed with the project, we thought the project was going to show very good resilience through COVID, we ultimately decided to be patient, and pull back on the deal. And then we shared the story of how we completed the raise, but over a long period of time. A raise that might normally take a week for us, actually took nine months, because we weren't selling it, we weren't pitching it, we were just simply waiting for people to contact us or waiting for people to ask questions like, Hey, I'm looking for an opportunity zone deal. And that enabled us to be patient, and to help people that had a need, as opposed to focus on ourselves focus on what we need, then it becomes a lot harder.

And the other element for us was, everybody that's ever raised capital over a long period of time, will tell you that deals get stale. Sometimes a deal feeling like it's stale is just as bad as it being a bad deal. Because people start to ask themselves, why have you been raising money for this so long, what's wrong with the deal? And so they start asking these questions. It's only natural. We joke all the time, I think we're both middle aged and single, so people ask what's wrong with you? Why aren't you married? And I say, Hey, hold on, give me some time. So we gave our deal a little room to breathe and a little opportunity to find its legs. And that was really important, as opposed to once a week, once a month, putting the deal out there, and putting the deal out there, and putting the deal out there, because sooner or later people are going to ask, Hey, why do you think you can't complete the raise? What's wrong with the transaction? And you know, what that would have done is that would have caused the focus to be on the deal itself, on the transaction, as opposed to the circumstances of the timing, which we really identified is the key problem.

So we gave the deal opportunity to breathe and not only that, but to get further along because if you're investing in a deal and we've already started putting in roads, or we've already started doing certain elements of construction, then you are investing in a de-risked point of the deal, because things have happened. And you're getting treated from an investment point of view is exactly the same as if nothing has happened, which is to the investors advantage.

In hindsight, all of this makes sense, but during the end of February, early March, was the answer obvious to you guys? Were you freaked out? Did you cry a little? What were the emotions during that time?
Nobody likes to feel like they're failing, and we certainly wrestled with that. Having just completed a raise that was bigger, on the adjacent parcel, we definitely second guessed ourselves. The thing about raising money that I always tell people is, sometimes the project's perfect, the situation is perfect, and you've just reached the limit of your network, if that makes any sense. Meaning that, I could find a perfect deal tomorrow, and if I needed to raise $100 million, I might not be capable of that. I may not have the network to do that. Or the timing could be off. What we really had to do was just think if we really think that we were incapable of raising this amount of money, or was it really just the timing. So there's a lot of self reflection involved in this. Unless you identify the real reason why you failed, or why you didn't complete your goal, in this case, or completed on a proper deadline, if you don't know the real reason, then you can't really solve the problem.

We didn't know if the market was telling us we're not interested in the project, or, we're not interested the project today because of what's going on in the world, we're not interested in you, everything's great but you don't know enough people with enough money to invest. These are all the questions we had to go through. I wouldn't say that we cried, we definitely consumed more glasses of alcohol as a result of this experience. When you have the dual threat of the public health crisis and the pandemic, and you also feel like your business is struggling as well, especially compared to your own expectations, it definitely can wear on you for sure.

We thought this was a great lesson and a great story to tell because it isn't perfect. And a lot of times we hear all these stories, Oh, yeah, I put a deal out and raise the money in 20 minutes, and you think it's a cool story, but you don't really learn a lot. For us, this was really all about being patient, and making the investors first. And everyone says that, but if the investors are first, then sometimes that means you don't slam somebody into a deal that's not appropriate. For some investors, their risk calculus was, we're not sure what's going to happen with the virus, and we want to get more clarification on these things before we invest. If we're trying to strong arm somebody into a deal, then we're not really putting them first. The patient strategy was the correct strategy.

I think we knew that at the time. I think we always knew we were going to complete the raise. I don't know if I was surprised or shocked on the timeline. And as much as we researched COVID, I don't think that any of us thought the United State's response and the success and failure the United States in terms of COVID would be as bad as it has been, in terms of just where we stand in the world. We were surprised too. Not a lot of tears, man tears, crying on our whiskey would probably would be our version of that. And just taking a step back and trying to diagnose what was the real reason why the raise wasn't as successful as we wanted. And we determined it was probably more due to timing and fear of the unknown than the project itself.

That's a great reflection to have during those times. How is the project doing right now?
It's going well, it's a little behind, but not especially so. The couple things we ran into were, with COVID, there were some municipalities that closed, for example, there's a city meeting that has to happen to approve your project and those got cancelled. Some of those state and local constitutions that want to give the public a chance to speak and so if meetings are canceled, we had some delays from that. There has obviously been some supply chain disruptions. So things that you order and you get them in six weeks, now it's taking 30 weeks, and price changes and things like lumber, that kind of stuff. We definitely battled through a lot of things. The project is very close to being on track. If we're not going to make up for lost time and get it back on schedule, then we just have an abundance of lessons along the way and things to think about. The average investor didn't really think about supply chains much a couple of years ago. Now, all of a sudden, everyone is so sensitive to those ideas and those concepts, and how to develop in a pandemic has been a crash course.

I know you already talked about how you guys reflected on if it was just you guys or the actual situation, but are there any other tips that you can give our listeners on how to deal with unplanned situations like this one?
If you were to think about all the things that it takes to write a business plan, I think the first thing you have to be is you have to be realistic. When you're realistic, and you're writing a business plan, one of the questions you should ask yourself is, how could this go wrong? What are the problems this deal could have, and then try to be creative and pre plan. So much about people that write business plans, it's all optimism. For example, if we just assumed, that we were going to raise this money, no problem, we hadn't set the floor, then we potentially could have had to rewrite the operating agreement, and that could have caused other investors to be spooked. Instead, we just said, Hey, this is the minimum amount we're going to raise, this is the maximum amount we're going to raise.

Always go through your business plan and just think through things that that could happen, maybe you won't raise all the money, maybe you'll have some price increases. You're going to need to have a healthy contingency, and things like that. A lot of what made us successful on this project, or come to a successful conclusion, really dealt with going in being realistic. And then also asking, Where can we have problems? And if we do have these problems, what's our plan in case we face them? Because having that in your back pocket, and when something does happen, you've already kind of planned for it. It helps a lot in the moment because you don't feel like you're being blindsided by something you couldn't see coming.

Loe Hornbuckle
loe@goodhorncapital.com
www.goodhorncapital.com