termination clause

The Duds – Walking Away From Contracts

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I just shared the details of the home inspection contingency in the real estate purchase agreements in my last post. I was laying the foundation to share what we’ve encountered to invoke the termination clause of the home inspection contingency.

COMMERCIAL PORTFOLIO

There was a time where we were trying to grow fast. We wanted to work smarter not harder, so we investigated commercial portfolios instead of buying one single family house at a time. We worked with our Realtor’s office’s commercial team to find an off-market deal of several houses. The owner of all these single family houses had lumped several houses in his portfolio by geographic area of Richmond, VA. He had provided us with 13 ‘sub-portfolios’ to review, but he was willing to sell individual houses.

We went through the entire portfolio to decide which houses we were interested in. We were able to eliminate several from the start because his rent to purchase price ratio were far from the 1% Rule we aim for (the monthly rent amount (e.g., $1000) is 1% of the purchase price (e.g, $100,000). We identified 10 houses we wanted to see and met up with the owner’s property manager to get into each house. Afterwards, we went through the list of houses, the comps we could find for purchase price, and discussed the condition of each house as we saw it. We ended up making an offer on 5 houses.

We received the ratified contracts on May 9th of that year, and we immediately contacted our home inspector to come through the houses with us. We met with the property manager, our home inspector, and our Realtor to inspect the 5 houses in one day. We negotiated with our home inspector that he didn’t need to write a report for each of the houses; I would take notes as we went through everything, and he wouldn’t charge us full price for the inspections.

We knew the houses weren’t in great shape, but we weren’t prepared for all the details we found in the home inspections. During our time at the houses, the tenants were quick to complain about the maintenance on the properties, saying things would take a long time to get fixed or they wouldn’t ever be addressed. The inspection found strong evidence of mold, patch jobs in structural beams in the crawl space, appliances not in full working order, windows screwed shut, and several other minor things.

We attempted to negotiate by the seller providing $10,000 per house in seller-paid closing costs. We didn’t ask for anything to be fixed because we saw the work that had been done in these houses, and we wanted it done right. The seller denied our request for funds to address the home inspection issues, and we walked away from all of the contracts.

FIRE DAMAGE

This was a hard one for me to walk away from. The house itself was in a high-crime neighborhood of Richmond. However, only THREE! parcels away, houses were being torn down, rebuilt, and sold for significantly higher than purchased. I saw the potential of the area’s revitalization. But we were not in the business of flipping houses nor doing major repairs. Not only were we not interested in that because we wanted to be able to create the cash flow as fast as possible, we also want to be able to hold these properties as rentals instead of flipping them so we maintained a continuous income stream.

There were several concerns when we walked through the property. The kitchen was a mess, there were signs of water damage in multiple places, the floor felt soft upstairs, the upstairs deck didn’t seem stable, the house needed a lot of TLC with the overgrowth, and then best of all – clear fire damage to the structure of the home when we went in the basement.

This isn’t a picture from when we were looking at the house, but this is the condition 3 years later, which shows just how ‘great’ of a house it was. 🙂 This is the backyard.

We were under contract for $72,500 in May 2017. The house recently sold for $296,000. Although it seems we missed the opportunity that I felt was there, I found pictures of a failed flip attempt in 2019/2020 that uncovered even more damage behind the walls than we even knew (although we suspected), and none of the houses around it have sold for nearly $300k. Therefore, we don’t believe that was a reasonably-expected sale price had we taken this beast on. And what’s not known in those numbers is just how expensive the flip was to that owner, both in headaches and wallet!

A KENTUCKY MESS

Mr. ODA went to see a house in Winchester, KY without me (it was easy because he was working near there, and it wasn’t worth me packing up our baby to go walk through a house that we may not even want). He and our Realtor walked the house and decided it was worth putting an offer in. The house had two units set up inside it, which was a goal of ours (duplex = one building the maintain with two income streams). The cash flow on it was great, so he probably turned a blind eye to too many negative issues during that first visit.

The inspection was $500. I was there for the event, but didn’t walk the house with the inspector. He ran through everything with me after he was done, but the tenants were present, and I didn’t want to bring my baby into their smoke-infested house (first red flag because we don’t allow smoking in any of our properties).

The first thing the inspector said was that the roof needed replaced. He pointed out that several tree limbs were in contact with the roof, and the roof had considerable algae growth on it. Basically, everything on the outside of the house needed repaired or replaced: siding, decks, roof, gutters, removal of vines on the house, negative slope of ground towards the house. The doors and windows were old and broken, so none had the proper seal to prevent water infiltration, in addition to not being able to maintain temperature.

On the inside, there were several code violations with how the kitchens were built (e.g., venting for range), and several large cracks in the walls, some of which were patched poorly and never repainted. There were five or six electrical issues that needed to be addressed immediately because they were a fire hazard. There were signs of water damage in the ceilings, as well as in the bathrooms where the peel and stick tiles were ‘floating’ and warped.

As if that wasn’t enough, the straw that broke the camels back for me was the head room given for the upstairs unit entrance. The required head space by code is apparently 6’6”, and we only had 5’6”. This seemed to be a big problem because an average man is 5’9”, and the average height of women at 5’4” doesn’t exactly give much wiggle room.

I was worried about all the work that needed to be put into this house. The tenants weren’t taking good care of the house, so it wasn’t worth putting a lot of money into it, just for them to destroy it. They had been there for a while, so it wasn’t like they were going to leave voluntarily any time soon. The neighborhood wasn’t in great condition, so a fully renovated house wasn’t called for when it came to resale or the type of client looking for a rental there.

It was a difficult balance, but the house had way too much deferred maintenance, way too many things poorly fixed/maintained when there was an attempt, several unfinished projects, and too many code violations to move forward. Mr. ODA really wanted to buy a house in this area before the summer was up, and he was pushing for the cash flow side of it since it had two separate units bringing in income. But that cash flow is non-existent if you’re having to put it back into the house.

These are the three main stories that have stuck with me. We learned a lot about houses through the process, and we feel we made the right decision on each of them to walk away. Through these experiences, we solidified our decision-making to focus only on houses that have been properly maintained and require little work to get rented. Having a unit already rented with long-term tenants isn’t always the “diamond in the rough” that you think it is.

The inspection is buying you information. Once you find out that information, the money is a sunk cost, and you should use it to now choose if the house is still worth owning or not. While inspections aren’t exactly cheap and aren’t tax deductible if we don’t buy the property (if you have a legal strategy, drop it in the comments please!), that information gained is important. That $500 “lost” is better off because you’re not buying a money pit that will cost a lot more in the long run. Remember, this is a business, and it’s best to keep your emotions out of it. Don’t pinch pennies and end up costing yourself big dollars later on.

Most times you’ll do an inspection, find some things to fix or negotiate down on the purchase price, and even find yourself in a situation where the inspection “pays for itself.” Other times, it doesn’t work like that. Life lessons can cost money, and inspections can help point out duds so that those lessons don’t end up costing a lot more.

Happy investing!

Home Inspection Clause

mrsonedollarallowanceLeave a comment

I’ve mentioned that you shouldn’t be afraid to [legally] walk away from a contract on a house that isn’t going to work. I thought it would be fun to run through the duds (houses) that we walked away from and why, but first, what is the home inspection clause and how does it work?

The home inspection contingency is a clause within the real estate contract that allows the prospective buyer to enter the home and inspect it before closing. The clause usually has an expiration date on it, meaning the inspection and any negotiations need to be done within X days of the contract ratification (ratification is once all parties have signed). I would recommend using a professional to look at the house, versus you thinking you can find the signs of a major a problem. It will cost you 1-2 hours of time and about $300-$600.

It’s important to note that even if a house is sold “as is,” you can still inspect it, ask for corrections, and/or walk away from the contract. “As-is” just means that the buyer should not enter the contract with the intent of the seller doing anything for them. But really, anything in life is negotiable, right?

Additionally, putting a home inspection clause in the contract doesn’t mean you have to perform a home inspection. So put the clause in there as a means to ‘escape’ if you need it.

THE LEGAL LANGUAGE

I was going to share a screenshot of one of our contracts, but the home inspection section is over a page long, so I’ll paraphrase. The contract was subject to a home inspection, and the Purchaser had to “provide the seller with all inspection reports, cost of repairs and Purchaser’s written repair request no later than 10 days after the Date of Ratification.” It continues to state that the inspection is paid for by the Purchaser, and the Purchaser cannot require the Seller to perform any inspection or pay for it. Then there is an outline for how long each party has to review the request and return it to the other party (e.g., negotiation period). Finally, there’s the clause that allows the Purchaser to walk away.

In one of our Kentucky contracts, it also states that all inspections must be ordered and paid for by the Buyer, and that the Seller must provide reasonable access to the property to perform inspections. Interestingly, the Kentucky contract focuses heavily on removing any responsibility from the Realtor(s) during the inspection process. I hadn’t noticed that nuance before, and now I’m curious how much has gone wrong in Kentucky that there are several sentences along the lines of “The parties hereto release the above Realtors and real estate companies from, and waive, any and all claims arising out of or connected with any services or products provided by any vendor.”

The Kentucky contract’s home inspection contingency is as follows. “The BUYER hereby agrees that he/she has inspected the property and hereby accepts the property and its improvements in its present “AS-IS” condition; with no warranties, expressed or implied, by SELLER and/or Realtors. BUYER may have the property inspected and may declare the contract null and void, with earnest money returned to the BUYER, by notifying SELLER or SELLER’s agent in writing within 15 days from contract acceptance. Failure to have inspection and notify SELLER or SELLER’s agent in writing within said time shall constitute a waiver of this inspection clause and an acceptance of the property in its “as-is” condition. The time frame established in this paragraph is an absolute deadline.”

I’ll say it again: I applaud Virginia’s plain language use in their contract templates. While the home inspection clause is lengthy in Virginia’s template, it’s written in an easy way to read and understand, unlike this Kentucky paragraph. I’ve also read New York’s template, and it’s even more painful to read and is written in legal jargon.

Quick aside. Virginia is a “buyer beware” state. This means that the seller does not have to disclose anything about the condition of the property to you. Whereas Kentucky requires the seller to fill out a form that identifies all known issues. Know the requirements where you’re purchasing/selling.

THE INSPECTION

Remember that you need to have the inspection completed and the inspector’s report written up with enough time for you to review it with your Realtor and decide how to proceed (e.g., ask the seller for repairs), all within the timeframe established in the contract (e.g., 10 days from ratification). If you want the house inspected, you should look to hire that individual within the first day of ratifying the contract.

When you hire a home inspector, they’re going to look through the house and identify any deficiencies. They’re looking at all the major mechanics of the house, identifying any safety issues, recommending repair/replacement, and making note of items that aren’t currently a concern but may develop into one. You should have a good understanding of the house’s foundation, roof, plumbing, HVAC, electricity, and appliances through the inspection.

While it’s not required for you to be there during the whole inspection, I’ve found it to be more helpful if you are. We’ve done it where we were present through the entire thing, but there’s a lot of down time for that, and we’ve been there just for the end to get a walk through of the findings. If you’re not there to see it in person, the pictures and explanations may not be completely clear.

The inspector will provide you with a detailed report within a couple of days of the inspection, which has pictures of the deficiencies and possibly an estimated cost of repair. The issue could be as small as paint imperfections, or as big as a structural issue. Here are some examples we’ve had on homes we did purchase.

BUYER’S NEXT STEPS

  • You can accept the deficiencies identified and take no further action. Sometimes there’s a contract addendum that’s required where you state you completed the home inspection and are requesting nothing from it.
  • You can request repairs from the seller, or you can negotiate the contract price to compensate for the deficiencies. The seller is unlikely to address superficial notes (e.g., painting), but may take notice for any major issues (e.g., gutters, roofing, HVAC). You can request the seller to repair any item from the list, but understand that you’ll catch more bees with honey. If you submit every item to them, they’re more likely to say no to many items on the list, and you no longer hold the control of what’s getting fixed. If you provide a short list that appears important, they’re probably going to accept the repair list. The list should be formally submitted (i.e., signatures) to the seller, and the seller should have to sign the list, agreeing to the repairs, within a certain period of time. As good practice, the buyer should be walking the property within a day or two of closing; you want to verify that the house is still in working order and the same condition as when you signed the contract to purchase. We did have an issue where the seller was not performing the tasks agreed to on the home inspection request form, and we had to make a few trips to the house to ensure it got done.
  • In extreme cases, you can invoke the termination clause and walk away from the contract. We did this on a house that several maintenance issues that were deferred and a structural issue; on another house that had several issues that were fixed poorly and one tenant showed us a huge mold issue in a closet; and on another house that had fire damage that was never fixed. Sometimes the seller will request the home inspection report. It’s a service you paid for, so you’re not required to provide it (but check your contract language to verify you’re not required to turn it over).

HOME INSPECTION MINDSET

If fatal flaws are uncovered through the inspection, you may feel like you’re committed once you’ve spent $500 on a home inspection; think of it in terms of how much you’ll save in headaches and costs down the road fixing all the things that you were made aware of through that process. Real estate investing is a business, and sometimes there are just costs of doing business that may not feel good, but are worth you moving forward in a positive direction in the long run. Just know that the home inspection contingency is a tool in your tool belt as a buyer.