When a Deal is not a Deal

A wise man once said, and many wise real estate investors have repeated it :  “You make your money when you buy, not when you sell.”

The point is that you don’t want to overspend on an investment or you can forget realizing a profit in this lifetime!  Sometimes it makes sense for a buyer who intends to reside inside his investment to be willing to pay a little more for it than a buyer who looks at a potential real estate purchase purely as an investment.    All tax “benefits” aside, you just don’t want to pay more for a property than it is worth!

So what can go wrong with making this principle the bedrock of your selection criteria for choosing your next property to purchase?

Fallacy #1:   Paying less is always cheaper.

Fallacy #2:  The best deals are only available through foreclosure auctions, REO sales, tax sales, or other deals you find some way other than through the MLS as a standard real estate listing.

We have a certain estate client we represent who is trying to sell a nice old Jaguar from an  estate of which she is the Executor.   The abstract value of the low mileage 20 year old English luxury sports car is impressive.   The market value is another story.  It turns out that if, unlike James Bond, you don’t have “Q” back at the home office ready to fix the car every time it needs a new part, you will invest a year’s wages keeping it on the road!   So offering the Jaguar through various auction houses at well below the appraised value has not yielded much interest.   The cars are just notoriously prone to expensive repairs.

Ah! If only there was some way to spot the Jaguars of Real Estate!!!   Like real life jaguars in the jungle, they have camouflaged coats and can be hard to spot.   On such potential deadly cat is a house for sale directly from a bank:  “bank owned property” or “real estate owned” or “REO”.   The deal may undercut similar houses in a given neighborhood by thousands of dollars.   At first look, you might choose the cheaper home or even get a recommendation from your inexperienced realtor that it is a “no brainer” to choose the cheaper home.   But those who have gone to closing a few times on REO purchases will know that the discounted price can come with warts in the form of repair issues or “clouds on title”.

In the worst case scenarios, the “Seller” is a bank or other lender affiliate that has never set foot in the house, knows nothing about the house, has burned all bridges with the former owners of the property, and is represented by an out-of-state law firm that just doesn’t care about local legal and customary rules of real estate closings.   That type of out-of-state closing company  is trying to use it’s VOLUME of REO sales to make up for being underpaid on each transaction.   It is a questionable profit formula when you think about it.   To some mathematicians, LOSS X VOLUME = BIG LOSS.   But I digress.  Based on my experience, the Bank’s attorneys on the sale of REO are just not paid enough to take the time to fix problems and will take any shortcut in their repertoire to avoid investing the time to fix problems of title.

Let me give you a hypothetical:  You put in a contract on an REO property at what appears to be 92% of market value.  8% instant equity, right!    The first unpleasant reality is that you are required to sign an infamous “REO Addendum.”   This is the classic form of which they say:  The Big Print giveth, the Small Print taketh away.   Many of the most important buyer’s rights in the standard (“REIN”) Purchase Agreement are stripped away.   You must buy the home AS-IS and with NO Inspection Addendum or rights.    If you want to inspect before you lose the right to get out of the deal, you must pay for an inspection before you make your offer!   What happens if the house has serious repair issues?  You lose $300+ per inspection fee and you are told that while you are waiting around for the inspection report dozens of other alleged buyers will take the deal and ignore the problems.   Make your offer today and sweat the small stuff tomorrow.

Even if your discounted AS-IS  home turns out to be relatively sound, you face another hurdle.  The title to the home may be saddled with unreleased deeds of trust, IRS liens, or judgments.  In the case of buying REO from banks that foreclosed on Reverse Mortgages, you may also have title issues from missing heirs and other challenges associated with real estate titles still listed at the court house in the name of a dead person.   Under a normal contract, with a local real estate attorney or title company representing the Seller, the burden clearly falls on them to deliver clear title or you can get out of the deal.    With REO sales, banks often take the position that “Our foreclosure attorney (an overworked attorney often compensated by volume) has already “cleaned up this title and gotten the bank title insurance and that LIEN you are worried about is not valid.”

Without going into all the nuances of title insurance, believe me when I tell you that not all policies are created equal nor is all coverage for a judgment, for example, the same.  We often object to the adequacy of how the bank claims to have “fixed” these old liens and demand more remedial work on the liens for our Buyers.    But the bank’s representative will inevitably offer the following resolution for the unclear title:   “If your attorney won’t accept the  title, let us do the closing and we will accept our own title and give you our title insurance policy for it.”   Why wouldn’t they?  They have already either messed up the title once or have insured over it once.  Getting your additional title premium to help buffer the possible future losses from their title errors is a no lose situation FOR THE BANK!!!   But taking their title insurance  can be a disaster for the Buyer who accepts a title from an REO company.    Ask us sometime about the practical meaning of Title “Insurance” being actually “Title Indemnity” and not really insurance!

On the other hand, it is not always an easy decision for you as the Buyer to make.  Picture yourself at the end of a lease, with a moving van loaded, or leaving closing on the sale of your existing home.  Your new mortgage and finances are lined up to buy this REO property.  The interest rates could be rising and your loan lock-in could be expiring.   You have nowhere to live with your family except in a hotel or in with your mother-in-law and the REO Seller refuses:  (1) to help fix the title flaw;  (2) to give your attorney more time to fix it on their own;  (3) threatens to charge you a $100 a day penalty or some other God-Awful penalty that was built into the small print of the  REO Addendum; and (4) threatens to sue you if you don’t close with their title company.

As if you were not under enough pressure at this point, the realtor with weak knees is often heading for the hills or for vacation.   They try to help by making their boss or broker happy by offering to take you to their in-house title company to close the deal.   Their in-house company  makes the same offer as the REO’s title company – “let us insure this for you . . . . ah, no we don’t technically represent you as your attorney does, but we will insure this for you!”.  Still no offer to fix the title flaw for you.

A good realtor will stand by you and advise you on what is in your best interests.  They will have been through this traumatic situation before and know that if you give in and settle for insurance and not a fix, you will be in a worse situation when you go to sell your investment later.  The person or persons that caused the title flaw or can fix it will only be that much older and harder to find.   And when you sell, the expense of fixing the title flaw falls entirely on you as the seller.  If you stand firm and force the title to be fixed when you buy, the cost falls on the shoulders of the Bank or its  “make money on volume” representatives who are selling you your REO house.   In either event,  the only 5% below market (non-REO) deal starts to look really good.  . . .  That deal you could have bought just down the street from the REO that has you feeling trapped . . . .  although it is a standard but possibly well seasoned listing on the MLS  . . . .  it could end up being a much less expensive deal in the long run if you buy it  with a good agent who knows how to shop for you with your criteria and best  interests in mind.  Along the way you might even  get your repairs done by the Seller, get some closing costs paid, and receive a clear title in a timely manner and without scary threats hanging over you.

The moral of the story is this:  (1)  hire a good and experienced realtor, who (2) uses a local real estate attorney for closing and not just a title company;  and (3) negotiates a fair contract for you or at least makes sure have “your eyes wide open”, i.e., you count the cost before you put in an offer on what looks like a cheaper home.    (4) It would be a real plus if your realtor can also offer you a moving van for a few days.

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