Sometimes Your First Loss Is Your Best Loss

Traditional Real Estate professionals have known all along that real estate flips do not establish value. The things we’ve heard for years, quality of construction, location, landscaping, and even subjective desirability, all have a place in determining value. What the last guy paid for that property, or similar property in a recent transaction, also plays a role. But we now know that the last guy may very well have been talked into buying the property with no thought of the traditional elements of value, but for what the next guy would pay because of the one after him. Obviously that approach had the effect of distorting value.

Now we see first-hand the danger of this Disney World approach. When the music stopped, the tragedy in personal financial terms, and the destruction to local and national economy are hard to appreciate until you see it up close. Every week I have people in my office who can’t afford to make payments on property they bought not for its value, but for the sole reason that someone else would buy it for more. Most of these people have bought condominium units that masquerade as income property, but with income streams that don’t come close to paying their debt. Others are not even income producing and just sit as assets on an income statement reflected at cost, while actual market value is much less. Unfortunately, the debt side of that balance sheet is very real.

This article is not written to point out the obvious, but to argue that it may be time to get real about value, and to get out of some of that property. The big picture is that the market sits bloated with over-purchased properties. There will be no sales if those who purchased for inflated amounts wait for those properties to be worth their cost. If we wait for that, many of us will be dead, if not literally, then financially.

A valued, friendly banker told me the financial adage “often your first loss is your best loss”. The advice seems good. No simple adage should ever be relied upon to make a complex decision. Those caught in that trap ought to seek the advice of their accountant to discuss when property might be sold if a loss must be taken. Find a lawyer or even your banker if you must sell for an amount that won’t pay off all the mortgages. Avoid foreclosures if you can.

Please don’t take this advice to be a statement that an owner has a right to sell and ignore existing mortgages. That is not so, and that would be poor advice. But the finance industry knows too that sometimes that industry is best served by a dose of economic realism regarding the value of security.

My advice in a nutshell? Don’t panic. Plan, and be honest. Let others help you. Don’t sell your 401K, and as a rule, don’t sell the home you live in. But manage the problem. Don’t wait for a “market correction” to make it better, because the market was not wrong. Traditional value has not changed, and the market is still there.

Bottom line: much of the property bought to flip is not worth its cost. Like the dog your child left behind, either keep it and learn to love it, or get rid of it sooner rather than later.