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Today's Topic: Foreclosure Headaches
Issue #010
March 1, 2005
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Foreclosure Headaches

- a reality check.

As a new investor, it's very easy to get excited about investing in pre-foreclosures. And there's good reason to get excited because it can be a very profitable segment of the real estate investing business.

But there are a lot of potential pitfalls in the business and it's a good idea to put things into perspective 'before you count your proverbial chickens'.

Ron LeGrand always used to say two things about banks that used to make me laugh at his seminars - yet I always took these comments with a grain of salt - until recently.

You can sum up the primary headache source with two words - Banks and Sellers.

If it weren't for these two aspects of the pre foreclosure business, there would be a lot fewer problems. The biggest headaches with both stem from time and reliability issues.

Question:

=> Do banks lie to you?
=> Do sellers who are staring down the barrel of a foreclosure tell you the truth?

Answer:

Yes, sometimes, to both.

In my experience, more preforeclosure deals - that have gone south at the last minute - have done so because of bank negotiations than any other single factor.

In most cases, in the preforeclosure business, you can control what the seller does by being very clear about your intentions, what processes will take place and where the pitfalls lie going into the project.

The other control mechanism is the documentation and knowing how to use it effectively. Always get the docs signed and notarized in the beginning - not in the midst of negotiations towards the end of the deal.

Lou Brown is adamant about 'controlling the closing.' Amen, brother. You do it with the paperwork - going into the deal. Paper can kill you in this business. So learn what you are doing before you get in trouble.

In eleventh grade, I had a chemistry professor who had a big sign above the blackboard that read: BEFORE YOU LOUSE IT UP, THIMK.

But when it comes to banks...

You really have no control in preforeclosures. Particularly in hot markets where banks can wait it out and get close to market after the auction or they know that there will be a lot of bidders on the subject property at auction if it actually goes to sale.

On the other hand, if the house is ugly enough and smells bad enough or has structural problems and multiple liens, it can be a lot easier to negotiate.

Over the last few years we have incorporated a variety of suggestions from many sources, coupled with experience to create a checklist of things to look for to ensure profitability and eliminate the possibility of a deal going south at the last minute - and avoid headaches.

1) Multiple liens help.

From the lender's perspective they know there is very little chance that the seller is actually going to reinstate the loan prior to auction.

From your perspective, you know that you can create equity by negotiating with subordinate lienholders - and the closer it gets to auction, the more incentive they have to discount.

Another point about mulitple liens is that many investors run the other way when they pull title and there are five, six or ten liens.

There is good reason for this from a conservative investor's perspective. It increases the odds of something going wrong in the transaction.

Greg Pinneo would refer to this as 'too many moving parts', for example.

From the investor's perspective, you, it can present a problem if your private money source is relatively conservative and does not understand the mechanics of liens and discounts. This can often be the case if the private money lender is a relative or business associate who has not been involved with funding creative transactions.

On the other hand, when I find multiple liens, I know that my chances of making money just went up significantly and the profitability with it. To me it adds flexibility and margin immediately.

But, it can be un-nerving and create anxiety on the home front if you are relying on a cash flow from this transaction to pay your bills.

Any time negotiations come into play it affects the time frame of the transaction and compounds the details that need to be dealt with.

If you have plenty of cash available for working capital and can stoke a check to buy a lien at a discount - the same day or within a few - it makes negotiating a great deal easier than getting a verbal agreement - or even a written one - from the lienholder and then not being able to come up with the money.

One of the worst factors this brings into play is it wakes the lienholder up (the sleeping dog) and he starts to think about getting more for the lien from somebody else - particularly if you are having trouble coming up with the cash.

2) Ugly Houses help a lot.

The reason for this is that you can get a lower BPO from the bank and it gives them considerable incentive to discount.

I have found that theses house are extremely easy to flip as well - and there are often two or three layers of profit margin available that do not exist in a pretty house.

Bank Headaches:

1) Lenders sell your loan to another lender during negotiations in a 'portfolio package' before you complete the transaction.

2) They drag their feet with paperwork and complicate closings.

3) They forget they agreed to anything with you - at closing - if you don't have it in writing, not unlike the IRS.

4) They will take less at auction than you actually offered them six months prior to the auction when you were negotiating with them.

5) Recently I have run into 'corporate moratoriums' on short sales. Speaking with a VP in the loss mit department, who was very saavy and pleasant, he told me the following:

In this particular case, the moratorium was not removed until about two months after the auction and I had the deed for almost a year - waiting patiently.

On this particular house, by the way, it was very ugly. The seller had his uncle-in-law (a wink-wink contractor) add a new gable over the front door several years prior. Unfortunately, after the install, water leaked right down the valley next to the new gable and rotted to the framing that supported the header on the front door. When I opened the door from the inside the whole wall started to come with the entry door as I opened it. I was able to push it back into place and closed the door before it fell.

My point is that this was a perfect short sale house and the actual repair quote from my contractor friend was about $5K compared to about a $30K discount.

6) You need a lot of cash at closing to cement the short sale.

Seller Headaches

1) Sellers lie.

Most of the time sellers are just confused people that are desperate and afraid. Many times when they have told me stuff that was not true, in retrospect, they had no clue what was going on in their financial life. And most of the time, they have no idea how a foreclosure works.

On the other time, I have seen sellers lie through their teeth, sell the house to mutiple buyers (or try to) and list a house with an agent after they sell you the house.

These types of people are out there and as a friend of mine who owns 50+ houses puts it,

2) It's Depressing Sometimes

I think the biggest draw back in the pre foreclosure business is a two fold problem.

The first segment is a philosophical/moral one. When you are in the pre foreclosure business, your profit comes out of dilemas and catastophies and bad events in people's lives. In other words, you are always dealing with people who have serious life problems.

Divorce, hospitalization, accidents, job loss, major illness etc...

Many of these people have all the equity they ever had in that house that you are buying at a significant discount and the only reason you are making money is they are losing it.

This bothers many people from an ethical and moral perspective - thriving off the bad things that happen to others.

The theory of the preforeclosure seminar people is that if you don't buy it, someone else will.

And that is 100% true.

It is also true that sometimes, many times, you are the only good news that they are going to have and you can actually help people a great deal in this business by helping them solve their problems.

On the other hand, you are a sapprophyte in a sense.

The second aspect of the problem is that many of the people you're dealing with in this business have horror stories to tell you and they are often depressed.

How the husband had an affair with his niece, how the spouse took all the money from the refi, gambled it away and never made a payment, drugs, doctor bills, divorce, etc...

Even though you are truly helping these people, in many cases, it can be a very depressing scenario and if you have enough deals going simultaneously, it can get to you emotionally and energetically.

Some people find that they are just not cut out for that aspect.

Time Headaches

I think, from a practical standpoint, one of the biggest myths about the pre foreclosure business is that you can quit your job in 90 days and start living like a king (or queen).

There is often nothing fast about negotiating with banks. They operate on a different clock than you do and if you need to make money fast, I would suggest some flips because it can be a significant amount of time before you realize a paycheck from a short sale.

This is not to say that a short sale can't get done within a few months. It is to say, however, that most of the time it takes at least six months - and often longer.

So the best approach is to have deals going on in different stages of completion and keep filling the funnel, as Ron LeGrand says.

But what the preforeclosure business is not is a get rich quick program. Most examples you will see presented at a preforeclosure seminar are the exceptions:

=> the couple who got 400 hundred phone calls in 5 days from their first radio ad
=> the guy who made $800K in one transaction (using a technique for advanced investors never taught by the preforeclosure seminar presenter)
=> the six people (out of 5000 or .01%) who made $100K in the first six months, etc...

The point is that there is money to be made in the preforeclosure business, lots of it.

But it may not be fast and it almost always takes hard work and experience to succeed.

If you have patience, enough capital and time and you are persistent, you will succeed but you need more deals than you think going into it, plenty of Excedrin, and maybe a marriage counseler so you can survive the dry spells and headaches in the beginning.

That's it for this time...

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See you next time.

Best regards,

Michael Barrett