CRE Lesson #4: How my First Deal Blew up, Got Saved, and then Became the Best Investment of my Career
Never give up on a great deal
"How does it look Juan?"
"Well, it's cracked."
"Hmmm, how bad is it?"
"It's a big crack."
And as I have learned since, the size of the crack is irrelevant. If the foundation is cracked, that’s all that matters.
The corner lot sloped up and away from from Highway 101 at the bottom of a hill whose other side boasted a postcard panoramic of the iconic San Francisco skyline.
And below the front left corner the wall bulged out like it was six months pregnant, 100 years of pressure from an underground spring seeping through the serpentine and pushing on the concrete until it gave way.
It was 2011, the financial world was still reeling from the mortgage crisis, and we were two years into a thus far unsuccessful fundraising effort at what turned out to be the bottom of the market.
1385 Kansas had been spun out of one of the dozen distressed portfolios sold during 2010 - 2012, deemed too small for its new private equity owner to bother with. They didn’t even give it a paint job.
The property was ugly as sin, across the street from a roaring freeway, had a cracked foundation and a rat’s nest of exterior piping hanging off wood siding that hadn’t seen a coat of paint in a decade.
But it was literally in our back yard, we knew the brokers were underselling rents by 30% and at that time no one – absolutely no one – was buying small apartment buildings in San Francisco.
But that cracked foundation threw a wrench into what we knew was a can’t miss deal.
My partners and I returned to the office after the inspection dejected, but optimistic that we could salvage the deal. We had lined up six investors at $60,000 each, but that initial $360,000 equity raise definitely did not consider a foundation upgrade.
But we naively believed that we could tell our investors about the findings, tout our competent due diligence process, use the discovery to get a price reduction more than making up for the extra costs, and away we'd go.
We immediately sent word to that trusted group of investors willing to back our first deal that we had discovered a cracked foundation and would be requesting a $100,000 price reduction for what we expected would be a $60,000 project.
All but one immediately bailed out.
(The one who stayed in was a long-time friend of ours who had stumbled into some Apple stock and was eager to roll the dice.)
That stung. After so many losses and no’s and rejection on the way to this point, to finally raise the money and find a deal, only to have it blow up in our face was brutal.
But we believed in the deal and weren’t quite ready to give up.
Our property manager and co-GP (if only we even knew what that term meant back then) had a whopping 25 units under management at the time, and subleased a windowless room at our office, which had previously been a production studio for gay pron (this is San Francisco after all). His father was a life-long real estate investor, and he mentioned the episode about the foundation and our original investors backing out.
His interest was piqued. He had been around long enough to know that when your casual real estate investor buddies were spooked, that was the time to be buying.
He walked the property and within an hour committed to taking the remaining equity - all $300,000.
And while a part of his interest was certainly to help give his son's business a boost, he was in it for more selfish reasons: he sniffed a deal.
And he was right.
The foundation project proved to be tricky and more expensive than we thought, but not dramatically so. We hired a grizzled foundation contractor who did us a solid by taking a $200 bottle of scotch in lieu of a change order, and within four months that corner of the building was as good as new.
Of the eight initial tenants, who were all paying dramatically below market, five moved out voluntarily, and over the next two years with moderate renovations, a paint job, waterproofing and some exterior love, we were able to take the rent roll up 65%. We cashed out all the original equity rode the boom.
To roll our equity into new deals my partners and I ended up selling our piece of the deal back to our primary investor, but when he finally cashed out in 2022, he earned 5-times his money and compounded at 60% IRR over an almost 11-year period.
He said it was the best real estate investment of his career, it is definitely our best deal to date and may be the best one I ever make.
The lessons I learned through that experience were so many it's hard to even note them here. I knew so little at the time that every single interaction, every call with the broker, every meeting with the contractor, every failed investor meeting was like an entire weekend workshop on investing in real estate.
But perhaps the one that I will never forget is that great deals get funded. Not everyone believes that, but I certainly do.
And that was a great deal.