Salvaging bad flip (defaulted loan/taxes overdue)

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Salvaging bad flip (defaulted loan/taxes overdue)

Karen Polis
King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes

Seeking ADVICE / Property is in Norristown, PA

I lent money to somebody (a land trust) for a fix and flip. Unfortunately, I did not do my homework beforehand, otherwise I would have realized there are 4 other investors prior to me that were already defaulted on for their loans. The Land Trust has just been served for back taxes.

All five investors are now in touch with one another and we are trying to salvage this deal to the best outcome for all. At this point, we only want our original money back–we are not even expecting profits, although that would be nice.

One of the original investors is trying to get the property deeded over to him so that he can finish the deal, however, we just learned that if this happens, it could wipe all of us other investors out completely. Since I am the last in line on this, I am told that I am the one who should be foreclosing. Also, if the taxes are sold, then we are all out of luck.

I am willing to buy the taxes to keep it in our control, but I don't know where to go from there. We have tried to get in touch with the land trust owner and of course, he is ignoring us. He even ignored several attorneys letters sent to him in the past. At this point, my guess is that he has used our money to live on and is running scared. 

All five of us investors have legitimate contracts with paperwork that tie us to the property, so in that sense, it is not a scam. But we can no longer rely on the land trust to make this right. The investors have to band together and because we are all newbies (obviously the land trust owner knew this)–we are not sure how to handle it. 

Any advice from people who have actual knowledge in this area and not just conjecture from reading books would be wonderful. 

Thank you! Karen.

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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
10y

So, I was able to research some more details on this property.

First, the loans.  All five had a initial principal balance totaling to $84,000.  That includes all five loans.  I'll call the borrower by his first name of Calvin; land trusts are supposed to be used allegedly to "protect privacy" - but in this case the name is in the public records anyway ...

Second, property was purchased for $28,000 by Calvin. In that area, properties at that price usually need full rehab. Looks like before Calvin bought it. it was listed on MLS in the $70K range, but the listing had expired.

Third is ARV (after repair value). This property has a few things not favorable to high ARV. It is on a busy section of state road, and directly across the road is an industrial facility and warehouse. And it is close to freight train tracks (but not near the railroad crossing where they blow the train whistle and drop the barrier across the road). it is close to the river but luckily not in the flood plain according to FEMA maps. But it is only a rowhouse (townhouse if you want to be fancy), so values will be lower for those. My guess is ARV around $140K, but could be lower if appraisers use the negatives against the property. With luck it might fetch $150K, but I wouldn't expect that or anything higher than that. It is in a desired school district.

The repairs needed are not known to me, but I would expect $40K to $50K minimum, and upwards from there.  If we have a flat fee listing, so let's use $400 for listing side commission,  and 2.5% to buyer's agent, plus transfer taxes for seller will be 1%, the math looks like this:

$140K x 96.5% - 400, or $134,700 possible to seller.  The adjustments for seller's portion of taxes and the back taxes still need to come off of that, as well as repairs.  If rehab is $50K, that puts the number at $84,700.  As you can see, there won't be any profit expected; probably best strategy will be to attempt to minimize losses at this point.

The biggest problem is this: it is facing imminent judicial tax sale (like less than two weeks away).  At tax sale, I would expect the high bid to run anywhere from like $30K to $50K based on the house and location.  So letting it go at tax sale won't get anybody paid except maybe first position; second position might get a little, but not much at the low end of tat bid range.  Karen has to figure out what approach makes sense for her, and whether she can do this within her SDIRA because otherwise it might put the SDIRA in jeopardy of being declared distributed by the IRS.

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    10y

    Well unfortunately, your money is likely gone.  

    Did all five of you receive/record mortgages for your loans?  No personal guarantees I suppose?  I don't know how the tax lien/deed auctions work in PA, but I'm guessing you wouldn't be getting actual title at this point, and you'd ad more money in trying to cure the same problem. If the lenders in front of you have mtg.s, they're not likely to give up much money to help you out.  Anyone past the first mtg has real risk of losing all their money.

    1Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Yes, we do have record mortgages for all of our loans. But no personal guarantees - do those even exist?
    All of those involved are willing to work together to make it right for everyone. We are trying to get the land trust to deed the property over to us without further cost. I don't know if there are any precedents for this?

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  • Greg H.Pro Member
    Moderator
    Broker/Flipper · Austin, TX · Member since 2013 · 4k+ posts · 4k+ votes
    10y

    Wow. What a mess !  You being in forth position does not give you much say in the deal unless you foreclose. Saying that you would be subject to the terms of the other 3 lenders ahead of you. Meaning, without an agreement by all, you would be subject to all the principal balances, back payments and any attorneys fees in addition to the taxes. That could easily exceed the value

    Without a written agreement with the other 3 ,  I would consider this a ltough lesson learned as you could easily end up throwing good money after bad money.  I would seek legal advice as well as a title search since the borrower seems to not be paying anyone and there could be some unpaid contractor and or suppliers as well

    1Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Thank you. We have done a title search. I didn't know that a title search could reveal unpaid contractors.
    So, it sounds like you are saying that I need to put into writing what my terms are before doing any type of foreclosure, because I would be at the mercy of the other 3 if the deed becomes mine due to buying up the taxes?

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    10y

    You won't get the deed by "buying up the taxes".  You'll only ever get the deed, for whatever that may be worth, thru some auction type sale, competing against others.  You REALLY need to sit down with a local real estate attorney who can explain your options, how the local tax sales work, and the likely outcomes to different scenarios.

    2Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Good idea. Thanks.

    0Reply
  • Greg H.Pro Member
    Moderator
    Broker/Flipper · Austin, TX · Member since 2013 · 4k+ posts · 4k+ votes
    10y

    You definitely need to see an Attorney and make sure it is one that specializes in real estate. The property taxes are a minor issue in this compared to the 3 lien holders above that any or all could hold out for all that is due including interest and penalties and attorneys fees

    I would also contact a local realtor to get a firm grasp as to the value as-is today and the after repaired value to see if there are enough dollars to make all the lien holders including you whole. 

    1Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Thank you - fortunately, one of the investors is a licensed realtor, so we have a few things covered on that end. There are 2 attorneys involved at the moment, although I personally, don't have an attorney. I may at least want to consult with one. We've been meeting regularly to work this out among the 5 of us. Being that we all feel swindled by the borrower, I doubt any one of this group is actually out to screw the others over. We will be signing new contracts to cover all of us and we also realize we may have to compromise on those original contracts. 

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  • Wendell De Guzman
    Investor · Chicago, IL · Member since 2013 · 2k+ posts · 1k+ votes
    10y
    Originally posted by @Karen Polis:

    Thank you - fortunately, one of the investors is a licensed realtor, so we have a few things covered on that end. There are 2 attorneys involved at the moment, although I personally, don't have an attorney. I may at least want to consult with one. We've been meeting regularly to work this out among the 5 of us. Being that we all feel swindled by the borrower, I doubt any one of this group is actually out to screw the others over. We will be signing new contracts to cover all of us and we also realize we may have to compromise on those original contracts. 

     Yup - definitely get a local attorney. I am not an attorney and below is not legal advice. I just have some experience in acquiring properties through Land Trusts.

    In a land trust, you have to know/ get:

    1. Who is the Trustee?

    2. Who are the Beneficial Interests or Beneficiaries of the Trust?

    3. Do you have the Trust Agreement copy?

    To be able to be in control, the Beneficiaries of the Trust can sign a document firing the current trustee (I assume this is the guy who put this whole "mess" together) and assigning one of you or one of the attorneys as the Trustee.

    You need to do this to ensure that you guys have the legal right to transact for the Trust which owns the property. You don't want the original guy to be in control because he is just ignoring this property now.

    So that's Step 1: Control the Trust by appointing a new Trustee (that all 5 of you trust)

    Step 2 is Find out everything you can about the property - what's going on with its insurance, back taxes, any unpaid utilities, any unpaid mechanics lien, etc? You can only do Step 2 thoroughly if you control the Trust.

    Step 3: once you know the problems, come up with a solution or several solutions. 

    What are the numbers? ARV, Repairs that are still needed to be done, unpaid bills, liens, etc?

    Based on the numbers, you can calculate how much the property should be sold for to cover these. If you can't sell and breakeven, your Trustee can negotiate with all the lien holders and see if they're willing to give you a discount (example: if there are mechanics lien of $20,000...talk to the contractor owed and negotiate to give him $4,000 as full pay off so you get a $16K discount).

    I know this is quite a lengthy answer but I hope this gives you a step-by-step framework for you to solve such a problem.

    3Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Wendell - this is a very useful answer (as was everybody else's as well). Thank you for taking the time to write all this out. I will forward this info to the others.

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  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Wendell - a question about "Firing the trustee."

    Sounds like you saying that we have the right to fire him from the contract and reclaim it for ourselves. I assume he would have to sign it over to us? 
    One of the issues we are having is that he won't communicate with any of us. He appears to be in hiding (at least from the people he owes money to).

    Is there some way to force him to sign this over or force him to contact us?

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  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    10y

    Wendell was implying that maybe the trustee was not working at the direction of the beneficiary.  I have a different opinion, that the trustee is likely doing Exactly what the beneficiary wants......as a land trust is one thing that scammers try to hide behind...anonymity, no personal liability, and all that.  No, you can not change the trustee yourself.

    1Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    Everyone knows this person- the borrower. He used to network heavily in the area. We've all met him in person. He told us from the get-go that this property is held in a land trust and gave both his personal name and the name of the trust. 

    I'm confused on the Beneficiary - is that the person who set the Land Trust up? As opposed to the investors?

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  • Greg H.Pro Member
    Moderator
    Broker/Flipper · Austin, TX · Member since 2013 · 4k+ posts · 4k+ votes
    10y

    I was on the road most of the day so I did miss a few details in your original post. I missed the Land Trust part and that you are in 5th position not 4th. A few thoughts:

    Getting the Owner to feed it to one of the lien holders does not wipe out any of the liens

    Getting control of the trust saves a lot of time and money but will require the cooperation of the owner

    The 1st lien holder is in a good position, why would he just not foreclose and wipe out the rest of y'all?

    One of the 5 of y'all will need to pay the taxes to keep it out of a tax sale

    What the hell kind of magic potion does the owner have to convince 5 people to loan him money ?

    1Reply
  • Percy N.
    Developer · Philadelphia, PA · Member since 2015 · 2k+ posts · 904 votes
    10y
    Karen Polis , I thought land trusts were not allowed in PA. I think you need an attorney to review this. Did you say the property was in Norristown? If so, is the value worth the effort? Perhaps Steve Babiak can suggest some resources. Good Luck!
    1Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    10y

    The beneficiary is the owner of the land trusts, usually the trustee is just a figure head, their attorney, or some other puppet for the beneficiary/owner, and yes the beneficiary controls the trustee.

    1Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y

    @Percy N. "land trusts" can be used in PA; see Brad Dornish article explaining why a land trust is not a good idea to use in PA:

    http://dornish.net/a-matter-of-trust

    @Karen Polis - I just did a search at the county recorder of deeds for the name "Polis" and I do not see any mortgage recorded; perhaps I missed it. So a bit more info would be helpful to see what is really happening - like the property address; free to message me privately if you choose / prefer to not post that here for all to see. 

    Regarding tax sales in PA. PA only has tax deed sales, but to complicate things PA has several different flavors of tax deed sales. Once taxes have been delinquent for two years, each September the counties conduct an "Upset Tax Sale" where no liens are extinguished, just the tax obligation is getting paid; this is like a "subject to" transaction but subject to everything of record. No recorded mortgage means no payout will happen should the property reach the point of getting in the Upset Sale. 

    1Reply
  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    10y

    Feel free to ring me.  I can take a look at this property as it looks like you in are in my area.  We sometimes are able to take other lenders out of a position depending on the situation.

    1Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    @Greg H. What kind of magic indeed! From what I understand, he has been flipping houses legitimately for 35 years. Though I imagine this is not the first time things went bad. He doesn't seem to have a prior record of shady dealings, but who knows...

    0Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    @Steve Babiak It's through my Self-directed IRA, that's why my name is not showing. I may contact you off the thread, though, since there are others involved here, I don't want to get too specific on a forum

    @Ian Walsh Thanks -I'll keep you in mind, however, at this point in time, I believe we are all wanting to wrap up the deal, rather than hand it over.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y
    Originally posted by @Karen Polis:

    @Steve Babiak It's through my Self-directed IRA, that's why my name is not showing. I may contact you off the thread, though, since there are others involved here, I don't want to get too specific on a forum

    @Ian Walsh Thanks -I'll keep you in mind, however, at this point in time, I believe we are all wanting to wrap up the deal, rather than hand it over.

    Well, if it is SDIRA money, then you have to be really careful in undertaking the rehab takeover.  The SDIRA would have to take title, and you would have to fund any further work from the SDIRA (or a non-recourse loan to the SDIRA - but nobody in their right mind would do non-recourse and be in sixth lien position). And your own activity would have to be limited to managing others who would be performing the actual labor. 

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y

    So, I was able to research some more details on this property.

    First, the loans.  All five had a initial principal balance totaling to $84,000.  That includes all five loans.  I'll call the borrower by his first name of Calvin; land trusts are supposed to be used allegedly to "protect privacy" - but in this case the name is in the public records anyway ...

    Second, property was purchased for $28,000 by Calvin. In that area, properties at that price usually need full rehab. Looks like before Calvin bought it. it was listed on MLS in the $70K range, but the listing had expired.

    Third is ARV (after repair value). This property has a few things not favorable to high ARV. It is on a busy section of state road, and directly across the road is an industrial facility and warehouse. And it is close to freight train tracks (but not near the railroad crossing where they blow the train whistle and drop the barrier across the road). it is close to the river but luckily not in the flood plain according to FEMA maps. But it is only a rowhouse (townhouse if you want to be fancy), so values will be lower for those. My guess is ARV around $140K, but could be lower if appraisers use the negatives against the property. With luck it might fetch $150K, but I wouldn't expect that or anything higher than that. It is in a desired school district.

    The repairs needed are not known to me, but I would expect $40K to $50K minimum, and upwards from there.  If we have a flat fee listing, so let's use $400 for listing side commission,  and 2.5% to buyer's agent, plus transfer taxes for seller will be 1%, the math looks like this:

    $140K x 96.5% - 400, or $134,700 possible to seller.  The adjustments for seller's portion of taxes and the back taxes still need to come off of that, as well as repairs.  If rehab is $50K, that puts the number at $84,700.  As you can see, there won't be any profit expected; probably best strategy will be to attempt to minimize losses at this point.

    The biggest problem is this: it is facing imminent judicial tax sale (like less than two weeks away).  At tax sale, I would expect the high bid to run anywhere from like $30K to $50K based on the house and location.  So letting it go at tax sale won't get anybody paid except maybe first position; second position might get a little, but not much at the low end of tat bid range.  Karen has to figure out what approach makes sense for her, and whether she can do this within her SDIRA because otherwise it might put the SDIRA in jeopardy of being declared distributed by the IRS.

    6Reply
  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    @Steve Babiak 

    Thank you so much for your analysis here. This is very helpful and appreciated. If your estimation of $140 or anywhere over $100 for that matter is accurate, then I believe it is worth it to pay the taxes and complete the deal. We are now trying to decide if we put minimum work into the house, can we recoup at least some of our money. We will not even break even, but would like to get something back, if possible.

    Upon going to see the house, it doesn't look good. It's in worse condition that it was 2 years ago. The porch and porch roof will need to be replaced. It stinks of mold and cat pee inside (we weren't able to go inside but looked through the open window). A tree stump in the backyard needs to be removed.

    We believe the borrower is not in his right mind. He had a stroke during this time period and I think it made him loopy. He's done things like buy borders and lawn furniture for the house rather than rehab it. He appears to be living there part-time. We saw him and he looks like he is on death's doorstep. I don't believe he meant to scam us. I believe he is sick in both mind and body.

    Hopefully, we can salvage at least some of our investment. In the end, it is just money and seeing him in his condition made me realize just how lucky and healthy I am.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y

    @Karen Polis - 

    Well, you can pay the taxes as mortgagee; that will remove the property from the tax sale. You would then have to proceed to foreclose on the property; I presume the promissory note and/or mortgage contain some sort of provision that failure to pay property taxes is considered a default event. So that would be your next steps. The legal costs to foreclose then have to be added to the expense column, so that makes the numbers look even worse. And hearing what you described as the condition there sure sounds like the rehab will be more expensive too. 

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  • Karen Polis
    OP
    King Of Prussia, PA · Member since 2013 · 38 posts · 9 votes
    10y

    The borrower has agreed to deed the house over to us. Whether he comes through on that is yet to be seen. He is not fit to complete the deal himself and I believe he wants to get it off his hands any way he can. We already have a lawyer drawing papers up on the transfer.

    Yes, I believe you are correct, that the rehab will be more around 50-60k. 

    I got into this deal initially with the idea that I would be project manager and learn what it takes to flip a house. What a way to learn!

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