What Not To Do In a REI Deal

Posted from the Charlotte REIA newsletter



What NOT to do! - by Cameron Dunlap



I received an email recently from a student in Akron, OH who was troubled (if not downright distraught!) by the actions of an investor in his market. The media and the public had made a big deal of it and the student's concern was that the impact this has on his market will make it difficult for him to do pretty house deals. And I believe he is right. But I also believe that with time the issue will fade away.



It seems that a woman in Akron, who will remain nameless, had built a large portfolio of properties by getting the deed and had re-sold most or all of them on contract/lease option. As you know, this is what we do every day. This is a large part of our business in general and at the core of what many of us focus on.



By most measures, this woman deserved credit for her success. The local newspaper article said she had over done over 100 deals like this.

So...what's the problem?



Well it seems that she is being sued by a number of sellers and buyers alike and as of the date the article was written, had nearly $800,000 in judgments against her. And it appeared that number would grow substantially because there were still a number of suits pending.



She is being sued by sellers and buyers alike, in some cases on the same deal.



Why was she being sued by sellers? It seems when she took the deed from some, and started making payments on the sellers behalf but then later stopped making the payments while continuing to receive payments from her buyers. Why she would do this is unknown to me but I would have to guess it was a result of a cash flow crunch. You might wonder how a person who had done over 100 of these deals and who was presumably making a profit could find herself in a cash crunch. The answer, in my opinion, can be summed up in a word. Spending. Her outgo exceeded her income and led to a cash crunch. Spending on who-knows-what, but spending none the less.



Under any circumstances, if we are collecting payments from a buyer on a house on which we have gotten the deed, and then stop making the payments on the sellers behalf, it is called "equity skimming" and it is, I believe, a felony. There was another investor I know who got nailed for this in Florida. The authorities and TV consumer advocates go to town on people who do this. And jail time is usually the result. So for goodness sake - don't ever do this!!



In this particular case, not only is it equity skimming but the sellers are suing her for what I presume is breach of contract. But wait. We are taught not to make promises or enter into any kind of contract to make payments with a seller. In fact we tell the seller that we will not make any future or back payments until we have put a buyer in the house.



The trouble, it seems, is that the court has determined that once payments start being made, the investor is entering into some sort of implied contract to continue paying. And because she stopped. the seller had obvious recourse. To add to the sellers case is the fact that the lenders are foreclosing and it's damaging the sellers credit. I don't know about you, but if I was the seller in one of these cases, I would sue too, especially if I learned that other sellers who had the same problem were suing and being awarded judgments. It appears that this woman's problem is snowballing out of control.



It gets worse. Because she is not making the payments and the lenders are foreclosing, the buyers, from whom she has collected down payments and given rent credits, are unable to buy. The buyers are in fact losing equity because they can't buy and as such are suing the woman and being awarded judgments against her too.



Holy smoke, what a mess!



So...here's my point: DON'T DO THIS. Once you have collected a down payment from your buyer and started making payments on behalf of your seller, don't stop making the payments! It's not only horribly unfair to the seller but it could be the end of your business. But what if there's a cash crunch? What if you are incapable of making the payments? Then go do a couple of retail deals and get the infusion of cash your business needs. Fix the problem with action. Proper action. Not inaction.



I think this also makes a clear case for diversification in your business. I like to mix it up. Pretty houses and Junkers. Lots of income from different areas of the business is another way to avoid a cash crunch.



And lastly, I think that this makes a case for living and operating your business within your financial means. Or in the words of my good friend Ray Rach, "Act Your Wage".