My First REI Deal

Well a week of my life has gone by, and I’ve had a number of emotional ups and downs. The source of this knot of emotions was my first attempt, along with my partner, to close a real estate investment deal. Here is the story, with as many specifics as I can give. While it is by no means an authoritative text on how to close a deal, it should hopefully give some insight into the risks associated with trying to rush a deal and the little problems that can become big headaches. I will outline first the timeline of events that encompassed the deal, then follow with my comments.





Monday, February 23rd



I took the day off from work to hit the courthouse and research a few properties I had seen in the newspaper foreclosures. I only had four on my list so I finished pretty early and decided to run by a home that I hadn’t researched.



My first impression of the property was that it looked deserted. There were no cars out front and trash was strewn about the lawn. Still, the home looked in decent shape, and the neighborhood was well maintained. Looked like a typical foreclosure, I imagined, as I had seen a full four other properties so far.



When I got home I started my due diligence. My process consisted of the following:

• Pulled the property record on Realist – this provided basic information on the property: who the owner was, when it was last sold, and tax records.
  
  
  • I found it was a 4 bedroom / 2.5 bath, approximately 2800 square ft, built in 1984, and had a tax assessment of about $210k. This fit in perfectly with what I was looking for.
    
    
  
  
  
• Ran a CMA
  
  
  • I found several properties that had sold in the last few months in the neighborhood, most in the 230k-270k range.
    
    
  
  
  
• Pulled all deeds listed on the property from the online database for the county.
  
  
  • Went through a paper trail of deeds and ended up with there being only one owner on record, with only one mortgage and a lien by the home owner’s association for $500.
    
    
  
  
  
• Printed out the plat map to make sure the property I was looking at matched up to the deeds.
  
  
• Checked the MLS.
  
  
  • I found that the home had been on the market for 6 months, but the listing had expired in October. The original list price was $270k, but it had been dropped to around $250k before it expired.
    
    
  
  
  

At this point, I thought I had enough info to justify digging further. I tried calling the owner, but his phone was disconnected. It was getting late so I gave up for the night and decided to see if I could track him down the next morning.





Tuesday, February 24th



I hadn’t really thought of a good way to locate the owner, so I decided I would just drop by and see if any of his neighbors might have any information. When I got there, I noticed a vehicle in the driveway, so I gave up on the neighbors and just knocked on the door.



The owner invited me in without even asking who I was. The inside of the house had seen some traffic, but it still looked to be in decent shape. There was definitely a change since the pictures that had been posted when the house was listed, though. A few holes in the walls had shown up, two busted windowpanes, and the place reeked of cigarette smoke.



The owner invites me to sit at the kitchen table and then asks me who I am. I tell him I’m looking to purchase a home in the area and I had seen that his house was listed a couple months ago. I asked if he was still considering selling it. Eventually, the foreclosure came up, and I asked very general questions to feel out the situation. He told me that the note balance was $142k, it was $7.5k in arrears, the PITI was $1300/month and there were no liens on the property.



During our conversation, he also said that he had offers from two other investors but hadn’t accepted any yet. He mentioned two, specifically. The first was for $10k up front, and $10k when the property sold. The second was for $17k up front and they would pay off the note immediately. I could see a number of letters on the table that seemed to lend weight to there being offers. I told him I needed to run the numbers and I’d be back later to talk.



I came back a few hours later and he had a neighbor over. The neighbor tells me he’s thinking of buying the house to save his friend’s equity. He says that the owner wants $37.5k of the equity or he’s not going sell. I just smile and nod and do not bring up to the neighbor that he isn’t going to be able to secure financing fast enough to forestall foreclosure. I decide just to chat for about 15 minutes and feel out the situation. I suspect they are bluffing to try to inflate my offer.



I presented him with an offer of $6k up front, $16k when I was able to refinance, subject to the existing financing. He had been drinking all day (the kitchen was literally covered in beer cans) and was prone to outbursts. I wasn’t able to explain the concept of how this deal would work very well, and his friend who was over didn’t help. The owner ended up telling me to “get the !#$@ out”, followed immediately by “come back anytime”.





Wednesday, February 25th



My business partner talked to our hard money lender and we secured a $25k loan to use on the deal should we be able to get a contract. We gave the owner a call and asked if we could drop by later to present him a new offer. He agreed to hear our new offer.



While we waited for lunch, I called the closing attorney I’d been talking to and asked him how fast he could close. He told me if I could get him a signed contract, a reinstatement letter from the lender, and a title search by the end of the day, then he could close the following afternoon.



During lunch we dropped by and presented the owner with an offer for $18k up front, subject to the existing financing. He asked how fast we could close, and when I told him we should be able to close the next day he agreed. Note that I used the same language as the day before, just a different arrangement of numbers. This time of course, he didn’t bat an eyelash at the subject-to aspect of the financing.



While we are there, I get him to call the mortgage company, and then I have them fax over a reinstatement letter for his loan to me. Turns out the owner’s numbers were a bit off. The reinstatement amount is for $9.6k, not $7.5k. While some of the difference is accounted for in foreclosure and legal fees, it seems he was still a bit off. The balance on his mortgage is also $152k, not $142k. Furthermore, his monthly payments are $1389, not $1300.



After we left I faxed over the contract and the reinstatement letter to my attorney. I informed him I’m having trouble finding someone to run a title search that fast so he says he’ll get his office to do it for me and that he should have it finished sometime the next morning so we’d be able to close on Thursday afternoon.



While discussing the deal, my partner and I notice a major problem in our contract. We have it worded that the owner will get $18k at closing, but that he is not moving out for a full two weeks later. This is obviously a bad idea, as he would still be living in the house while we were out of pocket almost $30k.



We pick up a case of beer and drop by the house to discuss the problem. The owner is surprisingly okay with the problem and agrees to amend the contract to be $2k at closing, the remaining $16k when he hands us the keys. While I would have preferred to give him nothing until we had the keys, it was the best we could do considering the original mistake.



While we are chatting it up with the owner, he lets slip he has a $200k medical lien on the property. When we inquire further, he says he was speaking hypothetically and there was no lien at all. The thing that made this strange was that I knew he had been in a major wreck within the last year that left him hospitalized for over 6 weeks. However, I had pulled the public records myself, and saw no evidence of the lien, so I just chalked it up to the alcohol talking. The smell of money was overpowering my good sense.





Thursday, February 26th



I decided to call my attorney first thing to find out how the title search is going. Turns out that for the first time in several years, we had snow, and the streets were empty. My attorney wasn’t in his office. Around lunch he returns my call to let me know that he had to stay home with his sick kids and that the title search wasn’t done yet. I’m not sure what the delay with the title search was, but I’m told that the courthouse was shut down due to snow. The attorney assures me we can close on Friday.



The owner’s friend from a few nights ago calls me at this point to ask me what the holdup is. I inform him the lawyer is out of the office and our closing has been delayed by one day. He is a bit upset, so lets the owner speak. The owner is again being difficult, but says that closing on Friday will be fine.



During the course of the day, a few tips from friends let me know how new to this game I am. I realize I hadn’t planned how to handle home insurance. My attorney tells me we can have the owner sign a letter to the lender notifying a change of insurance and we can then get a policy set up with the mortgagee listed, us as the primary beneficiary, and the current owner as the junior one (to help avoid DOS issues). After the new policy is in place, we mail in the letter.



The next problem to tackle is escrow. Once the owner is out of the home, and we begin making payments, we are of course paying money into the escrow for taxes. As soon as we get financing in place to pay off the original note, the mortgage company will cash out the escrow and mail the owner a check. Doing the math in my head I realize that in six months, the owner will get $900 that we have been paying into escrow for OUR taxes. Not only will we be out $900 for that, we’ll be out another $900 when the tax bill comes and our new tax escrow account is short! A quick chat with the attorney later, we have decided to have the owner sign a letter to the mortgage company stating that if the loan balance is paid in full, any outstanding escrow should count towards the principle rather than being returned to the owner.





Friday, February 27th



Another issue has crept up that might stop our deal. The owner had mentioned two nights before that at some point he had bought his former neighbor’s house, subdivided the lot, then sold that house to someone else and retained the split-off piece of land. Unfortunately, I couldn’t find any proof of this, and I had forgotten to mention it to my attorney for the title search.



I pull out the original plat map and notice that it doesn’t match the plat map I got off Realist. I find this odd, so do some searching and I can see that the neighbor’s house indeed had its lot subdivided at some point, and that according to the exhibit on the warranty deed for the neighbor’s house, it happened around 1996. The tax assessor has no idea who the owner of the “mystery” lot might be, so I do some more poking around.



Eventually I got lucky and found the resubmitted plat map dated two years after the date given on the warranty deed of when the neighbor’s house last sold. It turns out the mystery lot was merged with the owner’s lot in 1998, putting to rest the question of how much land went with the house.



It’s now lunchtime, and we are supposed to pick up our owner to drive to the closing since he has no car. Unfortunately, I haven’t heard back from my lawyer yet on the title search, and he’s not answering my calls. I decide to drive out to his office.



While I’m en route, my partner goes to meet the owner. Another investor happens to call while my partner is there, and the owner happily hands over the phone. The other investor tells us there is a $200k medical lien on the property. My partner gives back the phone and goes outside to call me. I tell him I didn’t know about the lien, but our property search was still in progress. Luckily our purchase contract included a clear title contingency, as well as one stating any liens other than a housing association one would render our offer null and void.



About five minutes later my partner calls to inform me that the owner has said he no longer wants to do business with us since he has a better offer. We decide to walk away from the deal, despite our contract. For one thing, the medical lien is a problem we can’t deal with and still beat the foreclosure. For another, the owner has been lying to us and is very difficult to work with. It’s just not worth our effort. We wish the owner luck with his new offer, and we get the phone number of the other investor to follow up with later.



At this point we don’t know if the medical lien is real or not. It’s possible the other investor is bluffing, but it’s equally possible she isn’t. We figure we’ll call her after we talk to our attorney.



When we get to the attorney’s office, the title search is still not done. We explain the situation and discuss filing a memorandum of contract to cloud the title. We decide that we will only do this if the other investor lied to us. If her story was on the level, we will bow out gracefully and wish her luck.



She calls me back about an hour later and she seems very sincere. We chat for a bit about the home and she tells me that she actually had a contract dated before I did. Not only had the owner not told her about my contract, he hadn’t told me about hers! I wished her luck with dealing with him and called it a day.





Summary



Well, I must admit I didn’t realize how many things could go wrong on one deal. But as it turns out, just about everything that could go wrong, did. So here are the problems I noticed, though there may be some that I have yet to discover. This has been a valuable “real life” case study - for a very minimal monetary investment.

• I didn’t get copies of the owner’s old mortgage statements. I waited until the reinstatement letter came back to notice he was wrong on the figures. Also, not having those statements made it impossible for me to know when the next payment was due should I cure the loan.
  
  
• I didn’t get copies of the owner’s utility bills. While most of these would follow him, water and sewer can be tricky.
  
  
• I didn’t ask the owner if he had signed any contracts. I trusted him when he said that he was still weighing the offers.
  
  
• I didn’t verify if the offers the owner listed to me were real. For all I know he might have really only been offered $1k total, and he was getting me to bid against a fictitious competitor.
  
  
• I offered way too much cash out of pocket. Considering my lack of experience, I was putting way too much risk on this property. Luckily I’ve now learned that there are plenty of deals out there that don’t require such a large outlay of cash upfront.
  
  
• My contract didn’t protect me adequately from the owner. Cash shouldn’t be exchanged until the closing, and the owner needs to have vacated the property by then.
  
  
• I didn’t have a way to handle home insurance in place up front. This isn’t something to do at the last minute. The current policy should be investigated ahead of time, to determine the best way to assure a smooth transition that won’t trigger a DOS clause.
  
  
• I didn’t have a way to handle the tax escrow in place up front. This may not be an issue for everyone, since generally you don’t cash out the owner later on. I was planning on living in the home, however, so this was an important issue for me.
  
  
• I didn’t properly research the issue of the plat changes. Had this deal been closed and the land description been wrong, I might have not been on the deed for the extra land.
  
  
• I didn’t factor replacement carpet and painting into my repair costs. While the carpet wasn’t in bad shape, the owner was a chain smoker, and this necessitated replacing them.
  
  
• I gave the owner my home phone number, since I don’t have a business phone yet. While at first I wasn’t worried about this, I quickly learned how bad of a temper he had. His jail time and his murdering friends convinced me that I’ll never make this mistake again. You have to protect yourself always.
  
  
• I tried to convince myself that money was worth the hassle of a difficult owner. Words cannot express how trying the owner was on my patience. I think the best (and most random) example of how he would constantly change his stories was him telling my partner that we were lying and there was no snow (causing the delay in closing), followed about 3 minutes later by a comment on how he wanted to go play in the snow in his front yard. A difficult owner can destroy a deal just as easily as numbers that aren’t working out.
  
  
• I pushed too hard to close the deal fast, without giving time for the pieces to fall into place. This indirectly was the driving factor behind many of the other mistakes I made.