How Our Deal Broke Down at the Last Minute—And Why I’m Happy About It

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I’m really a pretty nice guy. I’ve met hundreds of you in person and spoken to a few thousand more prospects/investors by phone or on Zoom. So, hopefully, most of you agree. 

But as I write this, I’m a bit miffed. You see, our Wellings Capital team is like family. We love and care for each other. So, I hate to see anyone on our team taken advantage of. But it feels like that’s what happened here. 

Our team recently spent over five weeks heads-down on what should have been a straightforward preferred equity investment. I did the due diligence trip in the fall. It was a beautiful mobile home park, and we were eager to add it to our investment portfolio.  

We were supposed to close the deal two weeks after my trip. Ben, Troy, and I had visited the team’s headquarters and felt we understood them quite well. We liked their team, their asset types, and their track record. 

Here are some details on the asset and the proposed investment: 

• The park had a significant waiting list (about 30 families), and homes typically sell within a day or two of placement by the operator.
• Lot rents were about $175 below market rate in an above-average location.
• 9% current pay cash flow to our fund, reserved for the first year.
• 6% compounded annual upside takes the total coupon to 15%.
• 2.5% origination fee, plus 1.5% exit fee.

As a preferred equity investment, this opportunity provided investors with a meaningful equity shield in the first loss position. And the operator, a 26-year CRE veteran, would sign a personal guarantee. 

We finally got to the closing table. The operator had spent weeks complying with our stringent but reasonable requests. We wired the money to the closing attorney, anticipating signatures the next day. We even emailed our investors with the closing announcement. 

Amazingly, on the morning of closing, the operator changed the terms of our deal. It wasn’t a complete overhaul of terms, but this was unacceptable—game over for us. We pulled the plug on the deal and got our funds back from the title company.

Do You See Why I Am a Little Ticked Off? 

This was a massive time drain for our team members and a significant disappointment since we had been conversing with this firm for over a year since our first visit to their headquarters. And it kept us from working on other opportunities. 

But it makes two simple points: 

1. It’s critical that you go to great lengths to perform appropriate due diligence before investing your hard-earned capital. 

2. Don’t move forward with a questionable investment based on sunk time or money costs.   

Passive investments can be a wonderful thing, but they can be a great source of frustration and loss if you link up with the wrong syndicator. It’s worth it to do the heavy lifting on the front end.

I don’t mean to sound arrogant. But we have reviewed and rejected hundreds of popular deals over the years. Many did quite well—while the tide was rising. Some have failed or are struggling in this receding tide. 

So Why Am I Still Happy? 

I have a lot of reasons to be happy, even amidst my irritation. Most notably, I’m happy because I’m satisfied that we did the right thing for investors and for ourselves (as fund managers). Because this deal could have gone okay, but it’s more likely there would be more trouble with this operator ahead. 

Are you a passive investor? I’m encouraging you not to skimp on due diligence. Invest the time, and don’t get emotionally married to any operator or deal. 

And there are much better ways to speculate. I wouldn’t do that in a real estate deal with projected returns in the teens or 20%-plus range. Why? Two reasons: 

1. Tech, pharma, and angel investments can have upsides of 1,000% or more. The risk-adjusted returns in most deals may stink, but there are those rare opportunities that create massive wealth for the lucky speculator. 

2. Real estate is a hard asset with (hopefully) real projected cash flows. It is perfectly designed for investment (rather than speculation). 

Sadly, many syndicators have dragged unwitting investors into speculative deals. The assets aren’t the problem. They were often solid properties with excellent cash flow potential. But the deal structure (overleveraging with risky debt, assuming rents would grow to the sky, etc.) is what got them into trouble. 

These syndicators turned potential investments into risky speculations. And many of you could figure this out through appropriate due diligence—either your own or through a trusted consultant. 

This is our hard-earned capital at stake. Don’t flush it down the drain. Remember: $50,000 lost or gained today could make a big impact on your future and the inheritance you leave behind for those who follow you. 

Plus, I don’t want to see you ticked off for the next decade.

Mr. Moore is a partner of Wellings Capital Management, LLC, the investment advisor of the Wellings Real Estate Income Fund (WREIF), which is available to accredited investors. Investors should consider the investment objectives, risks, charges, and expenses before investing. For a Private Placement Memorandum (“PPM”) with this and other information about the Wellings Real Estate Income Fund, please call 800-844-2188 or email [email protected]. Read the PPM carefully before investing. Past performance is no guarantee of future results. The information contained in this communication is for information purposes, does not constitute a recommendation, and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws. All investing involves the risk of loss, including a loss of principal. We do not provide tax, accounting, or legal advice, and all investors are advised to consult with their tax, accounting, or legal advisers before investing.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.