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Two Real Estate Investing Practices To Avoid

by Katherine Grote on January 18, 2013 · 8 comments

  
We Buy Houses Sign

I’ve never been one to really shy away from controversy and I guess this subject proves this to be so.  I feel strongly that there are many dubious practices in investing that should be carefully investigated before one jumps in with both feet.  I respectfully make the case for two practices that should not be commonplace for an investor.  I look forward to your comments and opinions!

There are two practices that I see that have taken root in our industry that I think should be addressed and paid close attention to.  Although neither are necessarily new, they seem to be growing in practice and commonality.

1. Mortgage assignments: “Sell an un-sellable house to an un-loanable buyer”

Shouldn’t that tag line alone make one question the strategy?  The premise of this niche reeks of the Clinton era (and continued on by Bush) National Home-ownership Strategy of ’94 and the belief that every American has the “right” to home-ownership.

The idea of this strategy is simple:  Take a home that has issues selling, usually because the homeowner is upside down, and find a buyer who can’t qualify for a loan to purchase.

Bringing the two together should be the perfect union and everyone lives happily ever after right?  The motivated seller has gotten out from under his mortgage, the unqualified buyer has a home, and the agent/investor walks away with a nice pop and no money out of his or her pocket.

All things that glitter are not gold!  Sorry, but this sounds like a recipe for disaster and one of the reasons for the housing market bubble burst.  Taking an unqualified buyer and putting them into a home where they are already upside down seems to be at best unethical.  Furthermore, you’ve now created a false market value for the property as in these situations the initial home-owner was already underwater, yet the home has “sold” for what the home-owner owes, not at a fair market value.

I know, I know, I hear the comments coming already, “But we’ve saved the homeowner from foreclosure!” We’ve made home-ownership possible for the one who wouldn’t otherwise have been able to purchase!”  Yes, but at what cost?  What happens when the unqualified buyer (possibly) defaults on the loan?  What if that family needs to move in a couple of years?  Isn’t it irresponsible to put someone in a home that they will be instantly underwater in?  Having said all of that, I do realize this system can work and I am not calling it a scam.  I personally know of individuals who have benefited from this system.   I also know of people who have been burned.  Is it worth the risk?  Could you as the investor/agent walk away with the cash in your pocket from the transaction and feel that it was a good deal for everyone?  If the answer is yes, then good for you and job well done.  As investors, we have a great responsibility and must never become so desensitized that we forget those around us who are also affected, for better or worse, by our choices and methods.

2. Wholesaling With No Access to Funding: Putting the Motivated Seller at Risk

Let me start off by saying our investment company loves wholesale deals.  Reduced risk, quick turn-around for a profit, and no money required makes for a happy day!  However, there are some very common wholesaling practices that are borderline criminal.  Inking a contract with a home-owner without a definite exit strategy and WITHOUT clear explanation (disclosure) to the home-owner… well, that is a very fine ethical line that an investor should be careful to walk.

Let me give you a real life story as an example:  Our investment company received a lead from a homeowner who was behind on their mortgage but had good equity.  When my husband had finally connected with the seller, he was too late.  Another investor had already made an offer that they accepted.   My husband had that weird gut feeling and told the homeowner, “Ok, but if for some reason they back out, keep my number.” Sure enough, a couple of weeks later we get a call back from them saying the investor had insisted on an “inspection” period, to enable him to find an assignee,  unbeknownst to the home-owner.  The investor couldn’t make it happen and backed out.

Here’s the problem:  That investor did not communicate to them his plan.  He wasted their valuable time, and the home-owners were now facing foreclosure in 3 weeks. This added fuel to a fiery trial for these people.  It took their situation from bad to worse, and put an immense amount of pressure on them as their foreclosure date loomed.  Fortunately, we were able to come in and purchase the home before it reached the court house steps.

You can say anything you want about a home-owner needing to do their homework before signing a contract, but let’s get honest.  Most of the home-owners we deal with are not experts on contracts or how a real estate transaction works.  Often they are in desperate situations where time is of the essence.  I am advocating a real and honest conversation between the investor and the home-owner so that they understand the risks involved and how the process works.  Using your real estate knowledge to mislead a homeowner is not only unethical but can also be considered illegal depending on your business structure.  Disclosure is always your best choice.

Realtors, inspectors, and mortgage brokers are bound by a code of ethics.   Real estate investing isn’t necessarily bound by a governing body regarding ethics but it should be just as important.  All are required to use practices that are legal.  But I would like to stress there is a difference between legal and ethical. One is required by the authorities, the other comes from moral principles.

Doing what is right is more important than doing what is right to make money.

Interestingly enough, one of the most popular key words/phrases we’ve seen come up in our internet marketing and research is, “we buy houses scam“.   There have been those that have gone before us that have given real estate investors a bad name because of practices that were questionable.  There are plenty of deals to be had out there by doing things the right way.  Don’t let fear dominate you or your business.  In handling every deal with honesty and the desire to do what is right, you will never go wrong.

Happy investing.

Photo: Matthew Wilkinson

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{ 8 comments… read them below or add one }

Brian Gibbons January 19, 2013 at 10:12 am

Hi Katherine,

Wow, emotional topic!

I personally am aware of someone who did over 800 sub2 deals and got convicted for fraud, see he did not pay the underlying liens like he promised. Owners got Notices of Sale. Rent to Own Buyers lost their house. This was in about 2003 or so, well before the Crisis of the Bubble.

I understand why RE agents are wary of being associated with unproven REIs; everyone, REI or Agent, has a RE horror story.

And Agents – Realtors sometimes do similar things, although it might me less obvious, like signing a listing with an unrealistic seller with little equity, then doing a price reduction on the last day. Then it is a he said she said story. And time is wasted too. Especially with distressed property.

Full disclosure is key. Both legal and ethical. If you want a great future in the REI Business.

Reply

Katherine Grote January 19, 2013 at 2:53 pm

Brian,
You are so right on. Disclosure is everything. And it’s true, these practices have been going on forever. I think it all just finally came to a head. I am all for creative financing and solutions to make deals work. Just not at an ethical expense.
Thanks for reading!
~ Katherine

Reply

Jason Grote January 19, 2013 at 8:06 pm

Brian, that is a great point about Real Estate Agents that give a seller false hope just to sign up the listing knowing that it will never sell at what they are needing or desiring. If money is what motivates everything you do, you will eventually fail.

Reply

Brian Gibbons January 19, 2013 at 8:25 pm

Thanks, Jason!

One of the things I do with non flipable properties due to low equity is either lease option flip to a tenant buyer or a sandwich lease option with some upfront option spread, spread in the monthly rent, and some back end spread.

Buying for cash for greater than 80% of comps in this fickle market is not my style, so I would rather control alot of properties. Most lenders will lend based less than comps. And my end buyers buy at bank appraisal, not comps, which can be 5 – 8 % less.

And sad to say, many agents are not trained in options or performance leases.

I would recommend the book, “Shift” by Gary Keller of Keller Williams, Chapt 10 talks in depth of creative financing. And I mean in depth.

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Lynn Andris January 20, 2013 at 12:54 pm

Could not agree with you more!
It is important to build a reputation for closing so save your money so if something happens you can close on the property yourself and add it to your rental portfolio, continue to find a wholesale flip buyer, or rehab and resell to an owner occupant.

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Steve Carlson January 20, 2013 at 3:11 pm

I am so glad you posted on that. Good read! I’ve been buying houses for 15 years and wholesalers who can’t close and assigning Subject-to contracts are what can very easily tarnish the RE investor community. If you’re going to wholesale PLEASE communicate the expectations to the home owner – be honest and up front with them. I buy houses subject-to but have refused to ever pass on responsibility of the underlying loan to anyone.

I appreciate your post. – Steve

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Jay January 20, 2013 at 7:10 pm

Hey Katherine,

Great article!!!!!

How would you recommend to a newbie wholesaler that I go about fully disclosing my intentions to the seller if the exit strategy is to assign the contract to another buyer and I am not intending to buy the home at all? What do you say to them and how do you say it? I don’t believe in leading people on and want to be upfront and honest at all times.

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Dan Marino January 23, 2013 at 1:18 pm

As a direct lender to real estate rehabbers/investors in NJ, I do see deals time to time through wholesalers, and I agree that locking up the deal without having lined up the buyer and disclosed this fact to the seller is bad practice. As long as the homeowner knows all the facts about the situation, he can agree to go ahead with the deal with the wholesaler or back out.

By the way, another practice I hate is brokers holding themselves out to be direct lenders. Lavallette funds deals from honest brokers on a regular basis, but occasionally, we’re needing to explain to the borrower why his fees are higher than initially represented, usually because of the broker not being honest about his role in the deal. There’s no shame in a broker holding themselves out in a straightforward and honest manner as an arranger of capital working on behalf of the borrower.

Reply

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