9 ways to avoid getting screwed in a business or real estate deal

I’ve had successful deals and not-so-successful ones. I’ve been screwed in deals: Non-payers, joint ventures who disappear, investments that don’t materialize. It’s insanely frustrating when it happens and every time it does happen, I get really angry — as much at myself for not seeing the warning signs as the person or company that screwed me over.

And yet, I do more deals because I know that the majority of deals turn out okay; that a few bad apples shouldn’t spoil the whole bunch; that, on balance and in the long-run, I’ll still be better for having done deals. I also view the bad deals as a type of education, which helps me find better deals in the future.

Note: I should note here that when I talk about getting screwed on a deal, it’s not always the case of a nefarious business partner who wants to win while you lose. Sometimes, and this has been the more frequent situation for me, you can get screwed on a deal when you work with one or more well-meaning business partners who innocently don’t value you or your time or efforts or skill as much as they should. There isn’t a dark purpose here; they just don’t realize what you bring to the table.

If you do deals, or want to do deals but are a little cautious rigtht now, here are a few tips that can help you avoid getting screwed in a deal:

1. DO YOUR DUE DILIGENCE

Don’t just jump blindly into a deal with someone who contacts you. Look into it first. Consider two things: The people involved in doing the deal, and, the upside (and downside) potential of the deal itself. This requires research — the one dreaded, arduous task that most people desperately want to avoid. Fortunately, I enjoy it and have found that a few minutes or hours of research and help to save or even make thousands of dollars. Research will help you understand who you are working with, and it can give you a dose of realism about the project’s potential. Due diligence won’t eliminate every instance of potential screwing but it will help you go into the deal with your eyes wide open to what the real potential is.

2. START SMALL

This is a tactic that I’ve adopted in the past few years: Don’t jump in with both feet, especially when working with someone you’ve never worked with before, or in an industry or business model you’re not familiar with. Rather than going all-in on a huge deal, start small. Work on a small aspect of the deal so that you can measure results and get into a rhythm with the person you are working with. Rather than co-authoring a book or building a massive business with someone, start on an ebook or blog just to test the waters.

3. GET IT IN WRITING

When you work with someone else, it helps to get the details in writing. Even if you forgo more formal, legal documents, it’s still helpful to know what each of your expectations are going in and what goals you have to work toward. On a couple of successful deals (but ones that had the potential to go south), we had information in writing that helped us to evaluate the progress of the deal as well as the expectations of each party and we relied on that to measure how we were doing and to hold each other accountable. When things started to go awry, we had a written document we could go back to and have a positive conversation about.

4. KEEP LINES OF COMMUNICATION OPEN

This one probably shouldn’t need to be said but it is a way to avoid getting screwed in a deal. There are actually two aspects to this: First, open communication between all parties helps to ensure that you are frequently and positively talking about the deal and nothing gets hidden away. Second, the act of communication, itself, is a way to keep a pulse on the deal. If communication suddenly dries up or becomes very one-sided or tense or accusatory, that’s a pretty significant warning sign.

Which leads me to the next point…

5. WATCH FOR WARNING SIGNS

When I look back at some of the earliest deals I’ve been screwed on, I laugh at myself for not seeing the warning signs earlier. There are all kinds of warning signs in a deal but often they are: Delays and rescheduling, actions without explanations, multiple excuses piled on top of each other, inaction, the conversation shifts to accusation, and blaming others. Sure, some of these might pop up once in a while on their own and you need to judge whether they are legitimate (i.e. there really was an unavoidable delay, perhaps because of a technological issue) or whether they are part of a larger problem. One or two of these things, once in a while, is usually okay. But the more these things happen and the more frequent they happen, the more likely you are about to get totally screwed in the deal. The trick is to see that tipping point as quickly as possible — to know when it’s no longer a one-time-problem but before it becomes a persistent problem for you.

6. BE INDISPENSABLE

Deals are done by people who want to succeed together. Implicit in that assertion is that each party believes the other person is a key part of the deal and has something to contribute. As long as you are indispensable to the deal, it’s not likely that you will be screwed. The moment you no longer contribute the value that the other person in the deal believes you offer, you risk becoming pushed out of the deal. In one deal, I bought a website. The person I bought it from was incredibly helpful and proactive… until I released the money from escrow. Once that was done, the project ground to a halt and although I now owned the website, the communication dried up. I still had the asset I purchased (which is why I used escrow) but I was left to do a lot more of the work afterward. That’s just one example using money to illustrate indispensability. You might be indispensable in other ways, such as in your network or the content you create or the way you can rehab a property. As long as the other person sees you as absolutely essential, you’ll probably not be screwed in the deal.

7. IT’S OKAY TO SAY NO TO CUT YOUR LOSSES

A few year ago, I put together a deal with someone in which I would do some consulting for him and his network. In a number of ways, the deal started to go south. I tried to end it once and was talked out of it. But I knew that I was about to get totally screwed on the deal so, even though I had invested some time into it already, I cut my losses and moved on. Saying no can (and should) happen before the deal even starts. But it’s hard to say no when someone is really selling us on a deal and waving promises of untold riches and fame in front of our faces, it can be hard to say no to a deal. And if you agree to a deal but later find out it’s going bad, don’t try to stick to it through to the end. Get out while you can. It will be painful but it’s better in the long-run.

8. TRUST YOUR INSTINCTS

Instinct is that mysterious voice in the back of your head that tells you that something is about to be wrong. I don’t understand why it’s there. I don’t understand how it knows. I don’t understand why it’s so often right. But it is there, it knows, and it’s often right. So if your instinct starts to tingle and nudge you away from the deal, listen to it. I have never ever ever ever regretted following my instincts. I have frequently regretted ignoring them.

9. BUILD CONTROL INTO THE DEAL

This is the one that has the best opportunity of eliminating the chances of you getting screwed in a deal. It’s also (in my opinion) the hardest to do. Not surprisingly, it’s the one I’m the worst at. When you control the deal, you ensure that even if you do get screwed, you come away with a benefit. In a real estate deal, perhaps it’s a contract on the property or ownership of the property itself. In a business deal, perhaps it’s the intellectual property or the patent or the website or the cash flow that you own.

I love doing deals. I love that rush of putting something together with someone else and watching it grow. But once in a while, a deal comes along that goes south. They happen. It’s the cost of putting yourself out there. But if you can implement some of these ideas when you’re first putting a deal together, you’ll be less likely to get screwed.

Case study: Revamping a sales funnel incrementally

When your business is struggling with making profitable sales, sometimes what you need to do is revamp the sales funnel — basically take everything apart and rebuild your business from the sales funnel, up.

The benefit of doing this is that (if you plan correctly) you can do it fairly quickly, without a lot of disruption. However, it can be costly and it can be potentially disruptive… especially if you rely on the income you generate week-to-week. So the other option is to rebuild your sales funnel incrementally: To identify all the areas of your business that need to change and then to develop a plan to slowly switch over to a new sales funnel in a way that doesn’t diminish your ability to market and sell to the people in your existing sales funnel. It’s more time consuming and potentially more costly, and sometimes it can feel like you’re juggling A LOT of balls at once, but the benefit is that you don’t cut out a week or month of sales.

One of my clients, a real estate investor, was facing this very dilemma. His business was suffering because of a change in the economy and he needed to make some dramatic changes in his sales funnel. However, he didn’t want to be too disruptive to the people who were in his existing sales funnel. So we put together a plan to switch him over slowly. (Actually, he came to me with part of a plan in place already, as well as a website redesign already underway).

We laid out the plan step-by-step:

  1. First we would create content for his new website.
  2. Then we would create an autoresponder series.
  3. Then we would offer a free report to entice subscribers.
  4. Then we would start creating passive income products to extend his income-earning opportunities.
  5. After that, we would look at additional marketing plans to boost his marketing, once he had a more automated marketing/selling system in place.

As I write this, we haven’t finished yet. We’ve implemented someone of these things and the rollout is going smoothly. However, we haven’t finished creating and implementing everything just yet. As I said, it’s a long-term plan so it takes some commitment but building your sales funnel incrementally can keep your business running while you transition.

How to overcome your fear in real estate investing… and start doing deals!

I know a lot of people who WANT to be real estate investors but aren’t. And the reason is: They’re scared. Some will admit it, some won’t, and some will blame it on an external factor or restate it with words like “unquantifiable risks” but it almost always boils down to fear.

For example…

  • There’s the fear of trying to find the money in the first place to do a deal (either the fear of asking at the bank and potentially blowing up your credit if a deal goes bad or the fear of rejecting when you ask other investors for the money).
  • There’s the fear that you’ll get totally hosed on a deal by someone, perhaps paying too much for a property that isn’t worth it.
  • There’s the fear that you’ll do the deal only to get totally hosed on the other side of the deal — by evil tenants or by a housing market that turns south when you are trying to flip the property.

Not to mention, the fear of liability, the fear of succeeding and having to make big changes in your life, the fear of spending money you don’t have right now, the fear of telling your friends that you are doing something only to have to face them later when it fails… I could go on and on.

So how can you overcome your fears in real estate investing? Well one of the reasons we feel fear is because of the unknown. It’s wired into our DNA to fear the unknown and to stick close to things that are familiar and comfortable. So the system I developed to overcome fear (which I’ve used when doing real estate deals, investing in equities, investing in businesses, or working through a tricky client assignment) illuminates the unknown, helping you move forward confidently.

It’s a surprisingly simple method that I call “sequencing” and it’s a system I developed while being a technical writer for an insurance company.

SEQUENCING YOUR WAY OUT OF FEAR

Sequencing is basically creating a detailed step-by-step list of the entire process or procedure or system or business model that you’re going to do. And it works for any kind of real estate investing.

Start by listing the steps of the process from start to finish, as best as you can. For example, if you want to be a landlord, then your initial sequencing effort might look like this:

  1. Get prequalified for a second mortgage
  2. Find a good property
  3. Buy the property
  4. Rent it out

You’ve created a really simple, basic list (or sequence) of the steps you need to take to become a landlord. But as you look over that list, you realize that there are many steps in there that you didn’t actually cover. So you go back and add a few more detailed steps.

  1. Find out how much downpayment is required for a second property
  2. Look for ways to access that money (i.e. Line of credit, savings, etc.)
  3. Check credit to ensure that it is optimized for the best possible mortgage
  4. Find a mortgage broker who can help find the best rates
  5. Get prequalified for a second mortgage
  6. Identify what qualities make a good rental property
  7. Find a real estate agent to work with
  8. Look for properties that fit the criteria identified earlier
  9. Put an offer in on the property
  10. Close the deal
  11. Advertise for a tenant
  12. Review tenant applications
  13. Sign a lease

Okay, this is a little closer to what the landlord sequence probably looks like. See? Already you’ve started to shed light on the process.

But you’re only getting warmed up! Now it’s time to go deeper. This is where you start to read, research, ask questions, get educated, and get mentored to fill in an even longer list. Look at each step in your sequence and ask yourself…

  • Can I narrow it down even more (perhaps by turning one step into several smaller steps)? If you can narrow it down, do so. In the 13-step sequence I listed above, each step could theoretically be narrowed down to even more, creating a list of dozens of steps. For example “advertise for a tenant” could be several more steps, including “identify the qualities of a good tenant”, “find the most effective locations for rental advertising”, “sign up at 5 rental advertising websites”, “create the copy for my tenant advertisement”, etc.
  • Do I know everything about that step or is there more I can learn? If you’re not sure how to get from one step to the next or how something works behind-the-scenes, make a note and go research that thing.
  • Do I feel comfortable acting on this step? This is a huge question to answer. Perhaps you can narrow difficult steps down into several easier, smaller steps (and you should try to do that) or perhaps you realize that one aspect of the effort is simply too difficult for you (in which case you need to find some kind of work-around).

Expect to create a list of dozens or even hundreds of steps.

“Hundreds?” you ask. Yes. Hundreds of steps. That’s okay. Another reason that people don’t become real estate investors is because they don’t know where to start and everything seems overwhelming. But by creating a sequence of hundreds of steps, you make it easy and obvious what you need to do next.

Keep going until you have created an amazingly detailed sequence that you can act on. Once you have the sequence, you have a step-by-step checklist that will take you through the entire process, with nothing scary or unknown.

That’s it! It’s almost so simple that you might wonder why you never did it before or you might wonder if it works. Trust me, it works. Build a sequence, act on that sequence.

Remember reading in Robert Kiyosaki’s Rich Dad Poor Dad book about finding a formula that works for him? That’s basically all this is. You’re building a formula in a numerical sequence.

BEST SEQUENCING PRACTICES

There will be times when you learn something that doesn’t seem to fit in your sequence. That’s when you need to ask yourself if you missed something (and add it in) or if there is a reason why this step might not be included in your sequence (i.e. it’s a step that is only done in certain areas but you don’t have to do it in yours).

Once you’ve done the sequence once, you may find that you can make it even better next time. Some steps can be eliminated, streamlined, or done concurrently with other steps. You’ll go faster (and probably more profitably) the next time.

And here are the two most important sequencing best practices (they work in tandem)…

  1. You can never be too detailed. You can create any sequence that is thousands upon thousands of steps, even for the simplest deal. If you need to do that, do so. The more detailed you get, the more knowledgeable you become… and the less fear you’ll have about doing the deal.
  2. A sequence is only useful if you act on it. A lot of aspiring real estate investors mistake research and learning for action. You should learn how to become a better investor but at some point you need to act. This sequencing exercise is designed to empower you to act but it is possible to still use it as an excuse for inaction (i.e. “My sequence isn’t complete yet”). So get as detailed as you can (see the tip above) but don’t get so detailed that you simply don’t move forward.

Bonus tip: Your sequence becomes an asset in your real estate investing business. It’s an asset that you can use over and over… and perhaps even sell to others.

Aaron Hoos’ weekly reading list: ‘Sales funnels, conversion optimization, and weird real estate investing’ edition

Aaron Hoos: Weekly reading list

Here’s what I’ve been reading this week…

  • The customer journey to online purchase. I love this report produced by Google! Without using these words, it basically shows an online sales funnel and how using analytics can give you deeper insight and enable you to sell more. Great stuff here!
  • 100 conversion optimization case studies. Last week I posted a long article I hadn’t finished but still recommended. This week I’m doing it again! Kissmetrics has posted a great blog post to 100 case studies of improved conversion. This is powerful stuff here and it’s impossible to read this without getting a ton of ideas for your own business! This is another one going into the “must do this for my site” file.
  • What if investors could help you buy your house?. This is an interesting and surprisingly informative article. It’s basically about a new potential way that people could buy houses — they could buy them with the help of investors (who would benefit with appreciation and some secondary market liquidity). Real estate investors are always looking for new ways to invest in real estate and this looks like it could be an interest possibility. I’m curious to see how it plays out — there are a lot of “moving parts” that could impact secondary market “share prices” on properties, plus investors may not get the regular cash flow that many want — but I find it compelling and would definitely participate in this if it becomes available.

Gotta keep the reading list short today. Got lots going one (plus one of them is really long anyway).

Capitalization rate: How to use cap rate in your real estate investing

The good folks over at Property Metrics wrote this very helpful blog post about capitalization rates in real estate investing. The post explains what cap rate is, how to calculate it, when investors should use it, as well as some alternatives that some investors use.

In my opinion, cap rate is one of the key metrics that real estate investors need to know about their properties — current properties as well as potential deals. Investors should memorize the simple calculation to determine cap rate so they can calculate it quickly (annual net operating income/cost of deal)

Admittedly, cap rate is a back-of-the-napkin type of of calculation and there are other factors that have the potential to impact the cap rate (such as a regular increase in annual net operating income or growing costs to maintain the property, etc.) But overall, this is a very servicable calculation.

There are three reasons why I really like the cap rate.

CAP RATES EXPRESS THE OPPORTUNITY (OR COST) OF RISK

I’ve been writing a lot about risk and risk management lately as I interact with Aswatch Damodaran’s excellent book Strategic Risk Taking. Cap rate fits right into the conversation of risk management because cap rates help you quantify the reward you get for the risk you take in real estate investing.

Many potential real estate investors scratch their head in wonder at how to determine whether or not a deal is worth doing. The cap rate, in spite of its flaws, helps to illuminate the answer. Investors can compare the cap rate of the real estate deal against the returns they can expect to get from other investments. In the article by Property Metrics, they give the example of someone who has $10 million to invest and they can invest their money in a property with a 5% cap rate or a 3 month T-Bill with a 3% yield (and is often called “the risk-free rate”). The difference between the two is 2%. That’s the return you get for the additional risk you’re taking over and above a T-Bill.

It doesn’t matter how much money you have to invest, the comparison is the same: Look at the amount of money you have to invest and compare your real estate investment options it to a T-Bill. The difference is the return percentage you hope to earn for the additional risk you’re taking on.

CAP RATES ENABLE YOU TO COMPARE ALL DEALS

When you are trying to decide if a deal is worth doing, or if you are trying to choose one deal from several potential deals, the cap rate can help you here as well. Cap rates reduce all of your deals down to one easy-to-compare number. So if you are looking at a commercial property or a bungalow or an apartment complex (which are 3 very different real estate investments), you can still easily compare them. Obviously this isn’t the only piece of information you’ll use to determine whether or not you want to do a deal but it’s a helpful piece of information.

CAP RATES HELP TO KEEP YOU ON TRACK

As the article indicates, cap rates viewed over a period of time can reveal trends. When you view cap rates for a particular market, you gain a glimpse of how that market is doing. When you view cap rates for your own deals, factoring in additional costs or changing values, you can determine how your own deals are doing. You can do this for individual properties, and you can do this for your entire portfolio of properties as well, gaining an aggregate view of the trend of your portfolio.

So get to know cap rates. Make them one of the numbers you pay attention to in your business and practice calculating cap rates so you can build up some confidence in understanding the numbers and using them.