“Cutting Your Losses Early…
Know When it’s Time to Bail on a Bad Deal”
by Attorney William Bronchick
When your primary plan of action doesn’t work, you need to have a backup strategy. This may involve switching gears from a retail sale to a rental or rent-to-own deal. It may also involve dropping your price, dropping your rent, or, if you are lucky enough to realize your mistake early, walking away from an earnest money deposit instead of closing on a bad deal.
If you already closed and your exit plan didn’t work out, sometimes the only option is to bail out and cut your losses. It takes a big person to look in the mirror and say, “I made a mistake.” Too many investors let their ego get in the way and hold on longer than they should and the bleeding never stops. If it’s a retail deal, then drop your price, even if it means losing money. If it’s a rental, drop your rent low enough to attract a solid tenant. If your monthly carrying cost is $1,000 on a unit, it makes sense to drop your rent by $80 a month rather than have a vacancy. In fact, if you’re offering the property on a lease with option to purchase, you may consider dropping the rent below market and taking a monthly loss to make it up on the backend, assuming there’s enough equity to justify the monthly loss.
For example, suppose you buy a house for $150,000 and it’s worth $200,000, but because of a poor financing choice, your monthly payment is $1,300 a month. Even if market rents are $1,100 a month, that doesn’t mean you must hold out for $1,300 a month. Too many investors think they need to hold out for the $1,300 monthly rent because their payment is $1,300. Wrong – the market will dictate what you collect for rent, not your monthly mortgage payment. If you have a high payment but sufficient equity, it makes more sense to rent it for $1,100 or even $1,000 to get a qualified tenant who can eventually buy it for $200,000 in two years. A loss of $300 for 24 months is only $6,800, which is justified when you make $50,000 profit on the backend. A word of caution, though: Never compromise your rental standards because it will cost you more in the long run for evictions and repairs.
Over the past few years, many novice investors got into pre-construction deals, anticipating a huge increase in prices by the time the development finished. Instead, the values had flattened or dropped. Rather than walk away from their deposits, many insisted on completing their purchases, hoping the market would come back. They are often wrong, and end up selling the property for less than they bought it for. If they stay in the game long term or have a viable alternative exit strategy (such as renting in the meantime), they may come out on top. But more often than not, the best course of action may be to cut your losses early.
Like the old song goes…
“You got to know when to hold ’em, know when to fold ’em,
Know when to walk away and know when to run.”