Real Estate Nerds 02: Bad Beats

Breaking Down The Postmortem Of Deals

Scott Sutherland

Investment property advisor

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On the debut episode of The Real Estate Nerds Podcast, where we give the information you need to be the best investor. We take a look at the human side of investing and ask some of the most successful individuals in their fields about their best deals, bad beats, and the lessons they’ve learned through their experiences. Today, our host Scott Smith, an asset protection and real estate attorney, asks real estate investor Scott Sutherland about the best deal of his life.

Scalpel, Please: The Post-Mortem of a Duplex Sale Gone Wrong

[1:00] Scott Sutherland has been investing in real estate full-time for eight years. Originally a product of the tech industry and traditional stock investing, he made his real estate debut after following investing strategists such as the Motley Fool. He credits his early success to bravery during a fearful time in the industry.

[3:30] Scott Sutherland talks about an investment that didn’t go as planned. He was limited by two things: being a passive investor and using a Self-Directed IRA for the investment. These circumstances meant he had little control over the investment beyond a certain point. Self-Directed IRA investments have additional limitations that prohibit investors from being directly involved in their investment. Doing so is known as “self-dealing” and would trigger a costly prohibited transaction.

[6:00] Scott Smith asks what made the investment in question appealing, Scott Sutherland points out that he felt comfortable with the asset class: duplexes in the Austin, TX market. Having dealt with hundreds of them over his career and feeling confident in the data, Scott Sutherland had no reason to question the asset itself.

[8:00] The two Scotts agree that Operating Agreements and deal structure matters when it comes to new assets. Even if an asset is great, the documents that dictate what happens when things go wrong can prove critical if things go South. Scott Smith drafts these for a living as a real estate attorney.

[10:20] Scott Sutherland points out that the asset he bought was four duplexes, but treated as a single property. Financing and sales issues changed dramatically because of this. Eight units would have had a lower “exit risk” than all eight taken as a whole.

[12:22] Scott Smith observes the importance of keeping deal-making processes consistent: “You can’t really control what happens with an investment. That’s an illusion. The only thing we can really control is the process that led us to a conclusion around what decisions we’re making.”

[13:00] Timing was an element in “lowering the bar” for Scott Sutherland’s process. “The hardest time to invest is when things are great…Confidence peaks the day before the crash.” Fear of lost opportunities, or FOMO (Fear of Missing Out), can also play a role in investors making poorer decisions in a hot market.

[18:15] Scott Sutherland notes that unstable markets yield higher returns, but the opposite was true in his case. The market was flooded. He believes he should have ignored return-chasing in favor of evaluating the relationship between risk and return for his particular deal. In retrospect, there were “ticking time-bombs” like seller-financed debt, that created higher risks from the outset.

[19:25] “If you borrow 80% of your investment and lose 20%, you’ve lost everything. Because you’ve lost all your equity.”

[20:00] Scott Sutherland points out his own sense of entitlement may have played a role in his loss. He was biased by having bought properties in certain neighborhoods for higher returns in the past, and neglected to look at the present situation for the asset and market. He has since realized his judgment was impaired: “I underestimated the risk because I was very focused on the return. I was very focused on how good things would go if they went well, and not on how quickly you could lose everything if things went poorly.”

The Red Flags Were There All Along

[21:00] Scott Smith speculates that a combination of external market pressures and internal biases contributed to Scott Sutherland overlooking some red flags. Since hindsight is 20/20, the pair are able to clearly see how the bad deal could have been prevented.

[23:00] Scott Sutherland actually addressed two issues with his operator planning to live in one side and rent out the other. First, he was concerned about debt refinancing if things went poorly. The operator claimed the creditor had pre-approved refinancing, and later disappeared. Scott Sutherland believes he was too trusting. He recognizes he could have taken additional steps, like calling the lender.

[25:00]  The second issue Scott Sutherland identified was that a partner was acting as a contractor, but they lacked a contract clearly stating what that person would make. He attempted to persuade his fellow investors to hammer this detail out on paper: “We all need to only make money if the deal makes money.”

[25:13] A simple provision limiting the amount the contractor could charge would have prevented this from becoming an issue.

[26:00] Scott also adds that having sponsors in the same position as you helps: “You want [sponsors] to worry more about the performance of the asset than you. If you’ve got a structure where the sponsor makes money no matter what happens, that’s a non-starter.” A sponsor who has this concern is more motivated to make the deal successful.

[28:00] While Scott Sutherland knew and trusted his sponsor, he could never have anticipated what ultimately happened. The sponsor, who had previously been reliable, walked away from all of his investors when this deal went south.

[30:50] Poor communication with the sponsor was also a red flag: “When they want your money and they aren’t getting back to you quickly, it makes you wonder how they’re going to be when they have your money.”

[32:50] Scott Smith points out how networking failed Scott Sutherland: “The true value of your network is in information that isn’t disclosed.”

Postmortem Results: What Investors Can Learn From This Bad Beat

The two Scotts evaluate what could have been differently, and ultimately see this bad deal as a lesson in risk. Scott Sutherland sums this up succinctly as: “Knowing bats 1,000.”

[35:10]  The two investors acknowledge that money can be hard to recover, but that losses can be lessons in resilience and better judgment.

Connect with Scott Sutherland

REN 01 | How To Tell Whether a Real Estate Deal Is Good or Not Scott Sutherland is easiest to reach via his website. He is generous with his time and enjoys offering his insights to fellow real estate investors. While his expertise lies in the Austin area, his knowledge can be applied to many markets and situations.

Listener Resources

Thank you for joining us on today’s episode of the Real Estate Nerds Podcast.

For even more free educational resources on real estate investing and the law, check out the Royal Legal Solutions blog. You can also reach our host Scott Smith directly, connect with him on LinkedIn, subscribe to the Royal Legal Solutions YouTube channel, or join our investor community on Facebook.

Don’t forget to subscribe to stay up to date and have the most current episodes of the Real Estate Nerds Podcast directly in your listening library. Every subscription helps us create new, custom content for you. What did you think of today’s episode? What would you like to hear more about in the future? Leave your thoughts and questions in the comments section below, or leave us a review in the iTunes store. We love hearing your feedback, so fire away. Join us again next week for the rest of a fascinating conversation with Scott Sutherland. Next time, Scott Maurer will share the dirt on an IRA deal gone sideways and teach us how to avoid bungling our IRA accounts. Thanks for listening!

Hosted by Scott Smith, Lead Attorney and Founder of Royal Legal Solutions. Schedule your personal consultation now. If you have questions about our content or suggestions for future episodes or guests, reach our podcast team at [email protected].

About Scott Sutherland

REN 02 | Breaking Down The Postmortem Of Deals Scott earned his Engineering degree from Texas A&M in 1995 and his MBA in Finance from Southern Methodist University in 2002. He is an active property investor specializing in distressed properties, rehabs, and buy and hold rental properties. He operates the web site to share his investing knowledge.