We had $12 million ready. But we walked away.

Hi {{first_name | there}},

Each Tuesday, I send a short note on commercial real estate to help you be a better investor. Topics may include deal stories, how I'm thinking about risk, lessons I'm learning, and market observations as we oversee our $500MM+ CRE portfolio and serve our 1,100+ investors.

Some weeks that means a deal that closed successfully. This week, it's one we walked away from at a late stage. Painful.

Last November, Wellings Growth Fund II and a sidecar vehicle had raised $12 million to invest in two Class A student housing properties, Knoll and Bridges, right next to the thriving University of Minnesota Twin Cities campus.

We didn’t close the deal. We returned every dollar to investors instead.

The operator negotiated hard, including an additional $3 million price reduction in exchange for a 30-day close. The properties were being acquired at a ~41% discount to the seller's 2017 purchase price. The seller had bought at the peak of student housing demand, then was hit by a run of setbacks: new supply in the submarket, pandemic-driven disruption to on-campus enrollment, and a wave of interest rate hikes that crushed their refinancing plans.

Rather than address the problems, the seller let the properties deteriorate; old fitness equipment, broken gas stoves, outdated furniture, and movie-room equipment went unaddressed for years because they knew they'd be selling at a loss. 

During a final document call, the operator declined to provide standard diligence items we require, including tax returns and documentation to verify their track record. This was after they had agreed to provide these documents.

Separately, their proposed legal language would have removed our liability protection, potentially exposing us to obligations beyond what we'd invested. And despite agreeing to our JV Hybrid Equity structure in the LOI, the operator declined to confirm our seniority in a downside scenario.

Any one of these would have given us pause. All three together meant we couldn't proceed. It was the right thing to walk away, but it was still painful.

By the time these issues surfaced, we were deep into this deal. Site visit. Background checks on the operator. Dozens of calls working through diligence questions. Completed financial modeling. Legal documents nearly final. Investors excited about the deal and the tax benefits. All $12 million in equity raised and waiting.

That is exactly when walking away is hardest. The more time and work you have put into something, the stronger the pull to find a way to make it work anyway, to rationalize a red flag, negotiate around it, or tell yourself it is not a big deal. That pull has a name: sunk cost. It is dangerous because it has nothing to do with whether the deal/operator is still actually good.

We try to ask the same question at every stage of a deal, especially late: if we were seeing these facts for the first time today, would we still do it? When the answer was no, the number of hours already invested could not change that.

One practical safeguard is to define your non-negotiables before you become attached to a deal. Otherwise, it becomes very easy to move the goalposts after many weeks of work, travel, legal fees, and conversations.

A fair question is: why had we raised capital before every diligence item was complete?

In deals like this, we typically have a narrow closing window, and final diligence, legal negotiation, and capital formation often run in parallel. We also do not rely on fund-level debt or bridge financing to close first and raise later. This was the first time we'd experienced an operator reversing course this late. 

We returned all $12 million to investors. In full. 

Our investment priorities, in order, are preservation of principal, income, appreciation, and tax benefits. We'll always choose the harder short-term path to protect capital over the long term. Business author Keith Cunningham once compared business partnerships to marriage: easy to get into, messy to get out of, and expensive.

Growth Fund II is open, and it's not sitting idle. The Fund's first investment is a multifamily property in a suburb northwest of Indianapolis, and we're actively evaluating additional opportunities for the Fund now. 

The same sunk-cost bias that made it painful for us to walk away can make it just as hard for an individual investor to pass on an opportunity after spending weeks studying it. Time already invested is not evidence that a deal is still attractive. And a strong business plan cannot compensate for legal protections that are unclear or weakened.

All the best,

Ben Kahle

Managing Partner | Wellings Capital | www.wellingscapital.com