My $23,750 Mistake at Olive 8

From Inspired Startup

A couple years back in 2006, I made the decision to put down a deposit pre-sale for one of the new condo projects in Seattle. In retrospect, it turned out to be a big mistake. Although I haven’t yet walked away from the deal yet since the closing date is still a few weeks away, it is almost certain that I will walk and lose my earnest money in the deal which totals $23,750. Although I’ve read about folks who are trying to get some of their earnest money back, in my mind, a deal is a deal, and I lost so I won’t be pursuing any of the earnest money. It’s a bummer, but I’m here to share my lessons learned. This post is not meant to criticize the developer of Olive 8, in fact I’ve got tremendous respect for him and all entrepreneurs that have a vision and put their money where their mouth is, I think it is a great project and I wish him the best. My purpose for this post is to walk you through my rationale for walking away and hopefully give you some insight as you are thinking about any large transactions – buying or selling.
The Hairdresser

I love my hairstylist, she’s an entrepreneur for many years, always done an excellent job, and provided great service. She is an immigrant and works hard and a truly inspirational person. Back in 2006, we’d converse about the real estate market and she’d get very giddy about the real estate market as did everyone back then, but what I should have realized is that when my hairdresser is giving me real estate investment advice, we are in the final stages of a bubble. Instead of using my head and going contrarian, I decided to follow the wisdom of the crowds and buy pre-sale at the absolute top of the market. Lesson learned.

Investment or Consumption

For me, I have to define my decision as whether or not the buying decision is based on financial factors or consumption factors. If it’s financial, then I need to make sure that I am buying below market because everyone knows you can never sell above market. If it’s a consumption decision (for example, buying a slice of pizza or going to a baseball game), it’s not about the return on investment, it’s about deriving enjoyment from the purchase.

I bought at Olive 8 because I felt it was a good investment and consumption decision. Turns out, it still is a pretty good consumption decision, it’s a nice building, but it’s absolutely awful as an investment decision. Because I want to buy below market, I want to know how the market is reacting to the building today. Turns out, several of the presales are already on Craigslist to be assigned at the 2006 price (a bubble price). To my knowledge only 1 has successfully assigned out of at least 8+ that I saw. The rest have failed even at 2006 prices, no surprise because 2006 was still very close to the height of the bubble. I’ve also watched closings on floors below me as closely as possible and my guess is approximately 12 units out of the potential 59 have closed. None that I know of in the “stack” that I bought has closed either. It’s terribly obvious that the units are overpriced despite positive press to the contrary.

Depending on who you are, if you view this opportunity or any other opportunity as a consumptive opportunity, buy it, enjoy it, and don’t look back. If you want to make it an investment decision, do your research and make sure you buy below market. Olive 8’s prices are more than 20% overvalued in this market.

Frozen Credit Markets

Financing is almost always required in large transactions as most people don’t have the ability to pay cash for a large transaction. So, determining how difficult it is to obtain financing for a project is always an important factor in valuation. For condos in Seattle, most banks require 25% down in cash (I have heard that some can go as low as 3.5% down (FHA) to 20%). That is one big nut for most middle-income Americans, especially with a negative (now, slightly positive) savings rate. It would be interesting to find out how many Americans can come up with at least 6-figures in cash. I suspect a very small percentage. Thus, the real market for the property is significantly less than what most of the sellers and the listing agents want it to be. Know your demand and use it to guide your decisions.

Bearish Timing

I don’t think that we are out of the woods yet in the economy and I remain even more bearish on the real estate side. We may have a small bear rally, but the fundamentals are still very weak, more companies are laying off workers, credit is tight, savings and investment is still too small. I just heard auto traffic has relaxed over 29% locally most of it due to layoffs. Being more patient and just waiting will prove to be very wise in the next 12-18 months. Have a thesis or belief about the market with regards to your transaction and stick with it. The developer is bullish that the market is coming back now so he’s sticking to his guns, if you think the market is still sinking like me, be patient.

Game Theory

In game theory, you need to anticipate what the other side is going to do and make your decisions based on that outcome. I have no insight into the developer’s equity and debt position including his ability to maintain debt payments with cash. I suspect, however, that should the units remain empty that prices must come down – it’s simply supply and demand. If I were to close on my unit and the developer lowers prices, I’m stuck and will inevitably have negative equity in my property which is something we’ve all learned through the past 18 months is a terrible position to be in (you can’t refinance, you can’t sell, etc). It would make no sense to purchase at 2006 prices if no one is purchasing them now and there are tons of empty units in 60 days. Play it out, be patient – no need to rush these days.

Raising Prices into a Down Market

I have to give it to the developer for being creative. I’ve always thought wouldn’t it be interesting to see if by raising prices, you can raise demand? Well, the developer has raised prices several times on its units since 2006. In fact, I know of a couple of units that have not closed go back to the developer only to see the prices go up. I’ll be watching with curiosity to see if it works out. But, the lesson learned here is to make sure you understand pricing history for the unit, it tells a story that is hard to argue with. If no one is willing to pay $435,000 for a place, will someone buy it for $495,000? I guess anything’s possible, but I would bet against it. Don’t get caught up with the marketing ploy of price increases and if you don’t buy it now, the price is only going to go up. Buy it because you want to consume it and/or you are buying below market value.

Amplifying the Mistake

Part of human nature (or, it might just be me) is to justify mistakes by amplifying it hoping for a different outcome – it’s insane. For example, if you bought Washington Mutual stock a few years ago at $37/share and suddenly it looked really cheap a few months ago at $3/share so you bought a lot more shares at $3 without really thinking about it instead of just selling at $3 to get out. Part of me just wants to go ahead with the purchase because I had already committed $23,750 to it, but it makes no logical sense. I’m only amplifying the mistake and hoping to hit a homerun to recover that mistake. Instead of amplifying the mistake, I need to let it go. Once you’ve realized you made a mistake, learn from it and move on, there are plenty of opportunities tomorrow.

In retrospect, it turns out the $23,750 was a call option to buy at Olive 8 that just didn’t work out. It bothers me with 20/20 hindsight, but I’ve learned a ton from the process and believe I won’t make a bigger mistake in the future because of it. Cutting your losses today can be counted as a win in the long run. What do you think? Do you think I’m making the right call here? Any other stories of how you are cutting your losses or seeing opportunities? Let your comments rip.