Never (Ever!) Offer a Distressed Seller This…

58

The flyer I left on Jack’s door that day explained I was a real estate investor. I could buy his house, pay cash and close quickly. Unimaginative, I know, but effective.

Jack was in foreclosure and needed help. Quickly. The auction date was less than a week away. I knew this because, desperate and out of options, he called after finding my bright yellow letter.

I was a little nervous to meet with him. After all, Jack had over $80,000 in equity in his home. With careful negotiation I could score myself a home run deal.

As we sat in his kitchen Jack described his financial situation. He was disabled from a previous job and living off the insurance. Some unexpected expenses came up and he couldn’t pay his mortgage. He got behind and couldn’t catch up. Sad, but not uncommon. I’d heard many stories like his before. I listened carefully and told him I understood.

Then Jack bottom-lined the deal – he would only sell to me if I allowed him to stay in the house and give him the opportunity to buy it back in a year or two.

Now I was told early in my real estate investment career to never, ever allow a distressed seller to stay in their home. It was explained to me that the day you bail the homeowner out of a bad situation you’re a white knight. But the moment things go sideways you’re the devil.

Still, this was an amazing deal. I thought, what could go wrong? Jack’s troubled financial past was behind him. All he needed was a second chance.

What Went Wrong

My company bought Jack’s house for $200,000 and he received $15,000 in cash at closing. He also signed a 12-month lease agreement and separate option to purchase for $230,000. His monthly rent payment was actually $150 less than his mortgage payment. In a year Jack would get his house back and I’d make $30,000 in profit. Of course, if he couldn’t exercise his option then I’d get to keep the house and all the equity.

Jack’s first lease payment, due February 1st, didn’t show up in the mail until March 4th. It was an out of state check that bounced. I never received another check from him again. Luckily for me, the eviction process in Arizona is swift and efficient. I had him evicted in 30 days. I wholesaled the house to another investor two weeks after that and pocketed $25,000.

About 11 months later a process server showed up at my door. Jack had retained a lawyer and was suing me for mortgage fraud. Worst of all, they named my wife and I personally in the suit. Never mind that there wasn’t any mortgage involved in the transaction (we used a standard lease/option agreement) – in this country anybody can sue anyone at anytime for any reason.

I retained one of the top real estate attorneys in Phoenix. Responses were drafted, depositions recorded, and motions filed. In all I spent over $40,000 defending our company from Jack and his frivolous lawsuit.

Finally, after more than 14 months of bickering Jack and I settled out of court – for $17,000.

Just Say NO to the Distressed Seller

That was 2006. The day I scratched that check for $17,000 I vowed never to allow another distressed seller to stay in their home again. It’s either sell to me and move out or no deal.

I highly recommend you use the same approach.

Here’s why – regardless of how you structure the deal (lease/purchase, lease/option, owner carry back, contract for deed, etc.) the homeowner will never be able to emotionally detach themself from the home. It will always be “their home”, no matter what name is on title. So when the time comes for you to evict or foreclose because of non-payment or inability to obtain new financing that former-homeowner-turned-tenant will fight you with every ounce of strength they have to stay because it’s really “their home”, not yours. The sweet, appreciative homeowner who once thought you were so wonderful and understanding will lawyer up and say you were a greedy, vicious liar all along.

The Short Sale White Knight

The game has changed a lot since I did that lease-option deal in 2006. I’m hearing about investors now that offer to purchase houses from underwater homeowners and then resell them back after the deal closes. There is a firm here in Phoenix offering to do this and has received acclaim from local news outlets for “helping out” distressed home sellers.

Take my word for it – it’s a flawed business model, and not just for the reasons I mentioned earlier. Most banks now forbid a short sale homebuyer from having a pre-arranged agreement with the home seller. Some of these banks even require the purchaser sign an affidavit stating no such agreements exist.

While allowing a distressed seller to remain in their home may seem like a noble endevaour, it’s really just prolonging the inevitable. There’s little chance they’ll ever be in a position to repurchase the home from you.

It’s much more probable they’ll come after you if they can’t. And I have 17,000 reasons why you don’t want that to happen.

Subscribe to our mailing list

* indicates required Email Address * First Name Last Name

About Author

Marty (G+) is the Chief Financial Officer for Rising Sun Capital Group, LLC, a real estate investment firm based in Gilbert, AZ. His firm purchases homes at the courthouse steps and public REO auctions. They have two exit strategies, either fix and flip or seller financing.

58 Comments

  1. What a hair raising story, Marty! I am very interested in Real Estate law- after reading your account, I am left wondering what happened in court that ran up $40,000 in legal fees? Did the case even go to trial?

  2. I am amazed by this story … though I should not be anymore.

    Don’t contract have validity anymore? Jack broke several contracts and came out ahead????

    • Kevin, I’ve learned from this that when a homeowner is in “distress” it doesn’t matter much what they sign. I’m confident if this case would have went to trial I would have won. I don’t think winning was the end game for Jack. He just wanted some settlement money, whether he was legally right or not.

  3. Wow, what a story. One thing I learned a while back about renting/selling the property back to the seller is that you’re setting them up for failure.

  4. Wow! What a terrible (and expensive) experience. I work a lot of short sales and most of the big lenders all have an arms length transaction affidavit specifically for this. Thanks for sharing.

    • Katherine, I met with an investor last week from California that wanted to build a business around buying and selling houses back to underwater homeowners. I really burst his bubble when I told him about the affidavits most lenders require the buyer to sign.

      Thanks for reading!

  5. Marty, that is terrible, but not surprising. So, we sometimes will allow the seller to have up to about 30 days to “transition” from the house they are in to their new residence. It makes for a nice selling point when buying their home. Any thoughts on how to do the wisely?

  6. In CA, there is a law which allows the former homeowner recourse IF they have equity in the house and the house is sold to an investor, and there is a current NOD on the house. The law date back to the great depression. I don’t know if AZ has the same law or something similar. It is to protect the distressed homeowner. Thanks for sharing your story. I would agree about the fact that people do get attached to their homes.

    • Gary, you’re referring to redemption rights. In Arizona, homeowners that lose their home to foreclosure have no redemption rights. It’s a big reason why there’s such a hotbed of investor activity here. There’s no risk the homeowner can get their house back after the auction.

  7. thanks for the story. Did you draft all the rental agreements and lease options agreement on your own with standard boilerplate forms? Or did you have a lawyer draft a copy tailored to this specific situation and deal? I’m curious if you think that having a lawyer draft a specific contract for the particulars of this deal would have saved you money and protected you. I’ve encountered a similar situation myself.

    Anyone can sue for the sake of suing and I feel like boilerplate forms/contracts are sometimes ineffective. In the future, I will have a legal review of deals in non-traditional situations even though there is an upfront cost involved.

    AGain, thanks for sharing your story

    • Jason, my purchase, lease, and option contracts were all drafted and reviewed by local real estate attorneys. Regardless of how well a deal is papered-up it won’t stop someone from suing you. It’s the world we live in now.

  8. Yup, wind up in court with a “previous” homeowner and you’re automatically the bad guy. Don’t do it, ever, even for 30 days. You close after they’re out.

    We were just talking yesterday about how hard it is to convince people of lessons learned. Just like this example, Marty, where you’d heard over and over not to do this but you thought this one time wouldn’t be a big deal. Sad, but people will read this, do it anyway, and end up in another bad situation.

    Thanks for sharing.

    • Karen, I’m not opposed to allowing a homeowner to stay for a few weeks, up to a month after closing as long as they sign a lease agreement. I also hold back half of their funds. This is usually incentive enough for them to leave. However, I would never allow them to stay in the house with the understanding that they could buy the house back from me.

      • I don’t let them stay. Period.

        Why? Just like you said in your first sentence “a homeowner.” If you end up in court, that’s also how the court sees them. We are always seen as the one who knows more and are considered taking advantage of the “uneducated” seller. No need to risk even 30 days. Nope, I won’t do it.

        • Karen, I’ve never had this be an issue before on a straight up sale. I’ve bought houses hours before the auction from distressed sellers – most of the time their heads are so far in the sand they haven’t packed up yet. It’s not possible for them to move out in a such a short period of time. That’s why I hold back a large chunk of cash – that motivates them to move quickly.

  9. Hi Marty,

    Thanks for putting this story out there! I get the chills just thinking about that. Glad that this experience has made you even stronger today.

    Best,
    John Fedro

  10. Marty,

    So true anyone can sue for anything, this should be the slogan of todays legal system. No longer does it seem justice is the final goal, but more a wearing away of will and finances of their victims. This the power of the legal system in today’s society.

    I hope this lesson has also taught you to make your company bullet proof, what good is a judgement if it cannot be collected?

      • Think about a family trust. Do you think you could get at the personal assets of either of the Kennedy’s or Rockefeller’s?

        • Dennis, I have a family trust and that did not stop Jack and his attorney from suing me. I’d be willing to bet the Kennedys and Rockefellers have been sued before too. The real fear for any business owner isn’t losing their assets in a lawsuit – it’s the cost of defending the lawsuit.

          I heard Mark Cuban, owner of the Dallas Mavericks basketball team, once say on a radio show that his biggest frustration is having to defend his companies against ridiculous lawsuits.

  11. Thanks for relaying this experience, Marty. I’ve been lurking here on BP for a while and this is my first post. I read with interest the amount of money that you ended up having to spend to defend yourself. My assumption would be that the former homeowner didn’t have money to actually pay for an attorney so he found one willing to work on contingency. I’m curious at what point you decided it was going to be less expensive to pay off (essentially) his attorney or if you just decided the on-going headache was worth the payout? I’m with the other folks here in saying you can sue anyone for anything regardless of merit. I had a similar situation years ago and finally settled after a long period of nothing happening just so that the situation was no longer lingering. I wish there was a way to make it not worth the contingency for the suing attorney so that they wouldn’t bring such frivolous lawsuits but I guess the only thing they’re spending on their side is time. Thanks for sharing the story so that I can learn from your experience without repeating it.

    • Karl, Jack’s attorney represented him pro-bono so he had nothing to lose. I figured it was going to cost me at least another 17K to go to trial, not to mention the time and stress, so I settled.

  12. What an amazing story. I know a guy in Portland who leased properties back to people who were in financial distress, and he has legal issues too. His problems were compounded by the fact that he went on a buying spree in 2006 and 2007.

  13. I have heard this story so many times and it makes me sad that so many investors do not know how to manage property. I mentor investors on buy and hold and property managers on the best practices for rental management.. The way to deal with this type of deal is to put the prior owner in a “rental agreement” for 6 months before you offer any type of lease. Treat them as you would any other renter on a buy and hold deal.
    Email me if you have any questions.
    Thanks Brad “The go to GUY” Meyer

    • Brad, this guy wouldn’t sell to me that way. He wanted the lease/repurchase option and if I didn’t give it to him another investor would have.

      For what it’s worth, I’m not a fan of lease/option agreements. Few ever work out and they set up the tenant for failure. Either rent the house, or sell it. Don’t mix the two.

    • Hi Brad,
      As a new investor I have already heard many similar horror stories about short-sales and foreclosures- enough to leave me a bit timid. I am confused as to how much risk the rental lease approach reduces. Wouldn’t the former owner still be evicted from the home that he emotionally still views as his own? Would this rental agreement prevent the investor from needing to spend thousands in legal fees due to irrational emotions of the former owner, who has nothing to lose and is being pushed by an ambitious pro-bono lawyer? Is there any good way to layer yourself enough to prevent them from coming after you or your LLC?

      Thank you,
      Perry

  14. Sure this happens but may be too broad a generalization. Should probably not generalize as to distressed homeowners either with current situation especially where homeowners rights have been ignored. Not simply a matter of everybody can sue everybody when lenders seem to be above the law.

    If 80% or more of foreclosures have legal issues probably a risk in any case. Settlement money should actually go to wronged homeowners so they can make a sound decision which can provide real opportunity for small investors. Otherwise business as usual will only benefit Wall St and foreign investors.

    • Luis, where did you get that 80% statistic? Here in Arizona very few foreclosures were handled illegally. The process is governed by state statute and there were no robo signing problems.

      I agree the banks should be held accountable, but I also think irresponsible borrowers who claim ignorance after that fact share some of the blame for the crash.

  15. Marty, you actually have 57,000 reasons not to do this. Interesting story, I’ve been advising people for years not to buy and lease option back to distressed owners because I knew what happened to you was a very likely result…but until now I didn’t know anyone that actually experienced it. Thanks for sharing. That’s the great thing about BP, people can learn from your experience for much less than $57,000.

    • So true Brian. And for what it’s worth, I had this happen to me two other times. Fortunately, the distressed sellers quickly realized they we’re going to lose so they dropped their cases.

  16. I’m currently in a similar situation. I purchased a short sale 2 months ago and agreed to rent back the house for a maximum of 4 months to the previous owner while her and her boyfriend purchased a new home (using his credit). I didn’t get the warm and fuzzies about making the deal but I really wanted the house. We are now halfway through the 4 months and they don’t have anything in contract and nothing in the works. They HAVE been paying their rent but I am not confident they will be moving out in two months without a fight.

  17. Marty –

    People will sue anyone in business these days, Investors, Owners, Agents, Brokers…
    Just got free from 2 separate lawsuits that both lasted 4 years. Both were settled with “Non-suit” results (meaning that they did not have enough grounds for trail). I refused to give in to those that tried to squeeze my company, and for those that filed their “frivolous lawsuits”, I will be going after them to collect on my attorney’s fees, plus.
    You gave in to easy. Paying that person $17,000 for what? Until people understand that there are alot of Attorneys these days that sue anyone just to get them to settle without a trial, that this practice will continue.

    • Kenneth, my business was circling the drain at the time and I was running out of money. If this thing would have gone to trial it could have cost me another 20-25K. In the end I believe I made the right decision. Jack had no money – the attorney handled the case pro-bono. I wouldn’t have seen a dime if I sued him for my legal bills.

      • I agree with Kenneth that settling encourages more frivolous lawsuits- but I fully understand that in this situation, it may have been your best option, due to your financial situation. We sorely need massive justice system reform in this country.

        Now, I am off to file a lawsuit against my previous landlord. (I’m not kidding- but mine is not so frivolous- he has failed to refund my deposit for over 3 months, and has not provided me with an itemized list of expenses, as prescribed by Missouri law, and repeatedly requested). I am not happy with the broken state of the legal system- the frivolous lawsuits will only make my legitimate one take a lot longer!

        • James –

          Just make sure when you file that you have a “bill of particulars” with the initial paperwork. Saves time and delay tactics of the Defendant. Again, I am not an Attorney, nor do I give legal advise, but relate via experiences I’ve had dealing with the legal and court system. I see that according to Missouri has a “Landlord-Tenant Agreement” in place and that If the landlord has wrongfully withheld all or part of a deposit, the tenant may sue to recover up to twice the amount wrongfully withheld.
          In Virginia we have the same type of law, with the exception of oral agreements. Good luck with this… you should do just fine in the court system.

      • Marty –
        A few issues that concern me with this. Anyone in Business these days needs to have an Attorney on retainer. Shop around for Attorneys- interview/evaluate them just like any other service you use. Know the laws/codes of your state that concerns your type of business. Know and understand the court system of your state/local.
        Understand, I am NOT an Attorney, nor do I give legal advise, but can only relate through experience dealing with legal issues.
        Most Attorneys will tell you that they will take care of all issues involved. Immediately you should have filed against “Jack” for naming you and your wife in the lawsuit. You didn’t need an Attorney for this, but could have gone in for a default judgement for filing a “frivolous lawsuit”. Further, filing with the State Bar a complaint against the Attorney who brought the frivolous lawsuit against you and your wife personally.
        Rules of every court I’ve experienced is to make sure your paperwork is complete and on time, this is where the opposing counsel loves to get a default judgement for you not turning in paperwork on time. Bottom line is to fight back and win. Yes it would have cost you time and legal fees, but in the end, you will not be labeled as a “mark” that will settle.

  18. I went for a leaseback on my first deal in ’78; no rent ever and the guy threatened me with a sawed off shotgun when I told him to leave…he couldn’t understand it was now MY house

  19. If this distressed owner tactic becomes prevalent, the only action an investor can take to avoid this is to wait for the lender to foreclose and buy the foreclosed property from the lender.

    • Kevin, let me be clear – I’ve never had an issue with a distressed seller when it’s a straight up sale. I’ve bought more than a 100 houses directly from homeowners in foreclosure and some hours before the auction. None have ever sued me. Most are grateful I came along to bail them out.

      The ONLY time I’ve ever had legal issues is when I allowed a homeowner to stay and agreed to sell them the house back at a later time.

      There will always be a role for honest real estate investors in our communities.

  20. Agree if a company (LLC, etc) has to pay legal fees to protect against frivolous law suits it has been pierce in reality. I wonder if a land trust would have protected privacy more, lawyers can’t sue what they can’t find?

    • Terry, perhaps. But creating elaborate trusts to conceal identities to avoid getting sued is treating the symptoms, not the disease. Since I stopped doing lease/option deals in 2006 I haven’t had a single issue with a distressed homeowner. Not one. That’s 7 years, more than 100 deals and not one lawsuit.

  21. Interesting history note -around 5000 B.C. or so when the Assyrians conqured a country one of the first things they did was move most of the population somewhere else. Brutal, but heck of a smart manuever psychologically, since no one is particularly interested in fighting to the death to defend a “homeland” that isn’t theirs.

  22. Marty, Great post. What organization and/or legal procedures have you taken subsequent to this lawsuit that would otherwise protect you and your family from lawsuits and the threats they pose?

    • Tom, entity structure was not the issue. Anyone can sue anyone at anytime for any reason. It doesn’t matter what type of legal structure they have in place. At the end of the day had this case gone to court I’m confident we would have won – and even if the tenant won all he would have got was an empty judgment against my LLC.

      The lesson here is don’t engage in a business that exposes you to legal liability. Since I stopped doing lease/options in 2006 I haven’t had any issues. I’ve done over 100 deals since then.

  23. Ouch, what a horror story :( Thanks for sharing…only had to go to court twice in my life so far (three times if you include my irresponsible, younger self speeding tickets collection :p), and that was enough for me to ascertain that justice very rarely has much to do with the procedure – it’s a capricious “who’s on first” kind of gamble on judge and jury personalities, which often even the best and most expensive lawyers can’t do much against.

    So happy to be dealing in old, tiny condo units – the tenants (we only source tenanted units) are virtually NEVER the sellers – since the typical tenant profile for these places would never be able to afford their own homes.

  24. Good article Marty! That must have been hard. I know a lot of local investors are doing what we do because we are fed up with how things have turned out and if we can provide some help, and make money too, then we try to the best of our ability. It is disheartening when you create a situation, clearly spell out the obligations, and still have to deal with the fall out because people don’t want to be held responsible for their actions. Sorry to hear that your not working lease options any more, but I can see why. I’m fairly new to doing them but so far everything has been rolling smoothly. The sellers need to be out of the homes before I’ll take possession and I even work with them by lining up a truck and movers, if necessary, as long as they pack everything. Not to mention I sometimes offer to give them a small portion of the option money from the tenant/buyer, but they have to be moved in order for me to move a T/B in. It’s incentives that make you look a lot less predatory and I keep receipt to write off as expenses.

Leave A Reply

css.php