Sell Your Property When It's Ready To Be Sold and Not a Moment Before

In this article, I wanted to shift gears a little bit and talk about a mistake I see a lot of developers make and folks in the real estate space who engage in some kind of value add activity. Selling your property too early can be absolutely lethal and I wanted to share with you a story to illustrate how it works.

The Story

Danny Developer acquires and develops a 5 unit apartment building and is making fantastic progress on the construction. After the building is fully framed and most of the interior is installed, Danny estimates that he will be completely done, which includes a certificate of occupancy and installed utility meters in 60 days. Noticing that his construction loan interest rate is currently 8%, Danny would love to time everything perfectly so that the building sells 30 seconds after completion to avoid paying any more extra interest to the lender.

Danny, in his single minded quest to save on paying interest expense, decides to sell the building completely vacant to a buyer with an investment objective to hold the property for cash flow. He estimates the property is worth $3,000,000 and immediately calls Bobby Broker to begin marketing the building immediately. Within a week, Bonny Buyer submits an offer for $3,000,000 with the main contract term being that all contingency timelines commence once the property has Certificate of Occupancy and all utility meters are installed and operational. Danny is super happy and accepts the offer and immediately places a reservation for a Lamborghini Aventador to be delivered in 61 days, feeling fully confident that everything will work out perfectly and he’ll be able to use his newfound profits to drive around the city in style.

Unfortunately, Danny’s enthusiasm for great execution blinded him to the chaos of a typical development project. After the property was cleaned and staged, Danny forgot to handle a few clearances required by the city’s building and safety department. He quickly jumped on it and sent in the right documentation (and fees) to the departments. Unfortunately, the supervisor who signs off on those clearances was on vacation and the supervisor’s counterpart was overloaded and couldn’t get to Danny’s project for another 2 weeks. ‘No sweat’, Danny thought to himself, ‘2 weeks won’t ruin the deal and there’s still time before the Lambo shows up in his driveway.’

Then the building inspector who Danny was chummy with retired all of a sudden. A new, younger inspector who was looking to make a name for himself with the city department was assigned to Danny’s project and conducted a height survey. He observed that the building was 2 inches higher than the approved plans called and let Danny know that no Certificate of Occupancy will be forthcoming until he remedies this situation. Neither the inspector nor the plan checker were willing to budge with leniency, which forced Danny to panic and consider ways to chop the inches off the building and still meet the building code. This caused a tremendous delay to the tune of 4 to 5 months. Danny quietly resigned himself to canceling the Lamborghini order and focused his energy on solving the “2 inch problem”. Bonny also called Danny every 3-4 days asking for an update and also snidely questioned his competence, which made Danny overjoyed and completely not stressed.

Around month 5, Danny’s friend told him he was interested in buying his property for $3,300,000 because rents were rapidly rising and supply for apartments was low. Unfortunately, Danny had to decline because he was already under contract with Bonny, who was impatiently waiting for Danny to get the building ready for her physical inspection. After 7 months, Danny closed escrow with Bonny. Bonny was thrilled to have gotten a steal on the property. Danny used some of the proceeds of the sale to buy a nice glass of whiskey and drown his sorrows. Right when he finished the glass and thought things couldn’t get worse, he glanced at his phone and read a text message from Bobby Broker, who informed Danny that Bonny sold the property for $3,400,000 to another investor a week later.

The Analysis

Let’s recap what happened. Danny severely underestimated the time it took to complete his project because he believed his enthusiasm would defeat the forces of reality. This of course never works. But also observe the other downsides of this deal. Danny missed a huge amount of upside to the tune of $400,000 and surrendered all of it to Bonny Buyer, who essentially acquired an option to buy the property at the low cost of $0. Danny also had to endure constant harassment from the buyer during the entire process, which probably shortened his lifespan and gave him a few more gray hairs and wrinkles. But he did save a 30-60 days worth of interest on his fully drawn construction loan, so that made it worth it, right?

The Lesson

If I had a dollar for each time I’ve seen the story above play out, I’d be writing this piece on my private jet on the way to the Maldives. The lesson to learn from the above is that you should never list your property for sale until you’re completely done with your project. Get your Certificate of Occupancy, have the meters installed, do a quality control inspection, handle repairs, have the property leased (if appropriate), and after all the foregoing have been completed, THEN I give you permission to call up Bobby Broker to list your property. By being completely ready, you will reduce uncertainty, which in turn will reduce risk, which then will maximize your sale price.

One last point I want to make is what if the above story had a twist? Instead of the property appreciating in value, Danny’s property declined in value during the contract period to $2,500,000 due to a rising interest rate environment. Danny is protected right? Wrong, Bonny in the above scenario would simply cancel the contract and get her entire deposit back from escrow (or renegotiate the price down to $2,500,000). By not waiting until the project was 100% done, Danny surrendered all upside, but also exposed himself to all downside as well. What a horrible outcome and one that I hope you won’t make when you’re considering selling your next property.

Always feel free to reach out here if you have questions!

-Stephen Morris, CPA, CCIM, MBT