How $85 saved me $19,000 on a Notes Deal

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I purchase non-performing 1st position notes. Like most notes investors I am used to seeing a lot of odd things during due diligence that can make or break a profitable deal. While my goal is to attempt to work with the borrower whenever possible to produce a win-win outcome (they stay in the home and begin repaying, and I earn a tidy profit for them doing so), in reality this only occurs for around 1/3rd of the deals I do. This is the story of a recent deal that looked like it was going to return a very strong profit for my joint venture partner and me in a relatively short timeframe. Boy was I wrong!

I found a non-performing 1st on a nice Florida condo in Boca Raton. The borrower was deceased, and the heirs elected not to remain current on the mortgage to the tune of 3+ years and counting. There were delinquent taxes and HOA fees outstanding. Simple stuff. After accepting the seller's counter-offer, I had a tentative agreement to purchase the note, satisfy the outstanding taxes, pay the back HOA fees (up to the 1% Florida Safe Harbor maximum) and foreclose on the property. All in, the estimated costs from acquisition of the note to foreclosure to either sold or rented would have been approximately $19,600. The rental comps for the complex and immediate area are strong, and the deal looked like a slam dunk.

Enter the $85.00. Since the seller had been slow to produce the electronic copies of the loan docs I decided to get in front of the curve and ordered a "full title" O&E report from a reputable vendor.

It turns out that full title O&E reports can miss a few things because it seems that not all liens need to be recorded. It wasn't the vendor's fault. Who knew?

As is typically the case, once I receive the electronic copies of the loan docs I send them off to a document review company where they look at the assignment chain to make sure all are recorded correctly, as well as review the title report AND the O&E. We were missing a few assignments, but again, nothing terrible. Here is where the fun started.

I called the county tax authorities and got the scoop on the delinquent taxes. Easy to pay them off. CHECK. Spoke with the HOA attorney to offer a settlement as they know if I foreclose I can simply wipe out their position as a subordinate lien. CHECK.

But wait. As we concluded the dance to get to a payoff number, the HOA attorney casually mentioned that "it really doesn't matter, because the land lease lien will wipe you (ME!) out anyway, so we both lose." WHOA! What?

I wasn't familiar with a land lease lien. And there couldn't be one on this particular property anyway, because the O&E report didn't show any such thing. Except there was. I called an attorney friend of mine who explained what the heck a land lease was in the first place. He told me that land lease liens are rare (mostly found in FL and CA) but are considered Super Liens when they do exist - and that I should run like heck away from this note investment. But I wasn't convinced yet. The deal just simply looked to good - with projected returns north of 30% annualized for my JV partner and me.

Next I called the document review company and asked about the impact of a land lease lien and why they didn't see it during their preliminary doc review. They didn't know the answers to those questions. So then I called the company that produced the original O&E report. As part of their fee they guarantee to rerun the report if I ever have a question about any information on there. In this case, I explained the issue, so they ran a "100 year" title search. And voila! There it was. Clear as day. To make this long story short, we decided not to pursue the asset, saving the $19,600 that we would have surely lost to the Super Lien foreclosure.

Moral of the story, due diligence is a critical part of note investing. O&Es are an important step in the review process, but they are not perfect! Be sure to call everyone involved and try to get the back story from each. If that attorney had not tossed out the Land Lease Lien comment, we would have had a very different outcome. While I wasn't pleased to have to make the call to my joint venture partner telling them we passed on the note, we both know this could have gone terribly wrong. Our money is safe and already deployed on another Note that will produce similar returns. What about you? Have you had any unusual issues like this one that you are willing to share with the group? We all benefit by hearing them as it can only help our due diligence efforts.

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Very informative post. Thanks Wayne.

@Wayne

Definitely thank for the informative information. Since I live and do business in Florida, I need to go and research what is a "Land Less Lien". 

Thanks...

These are actually "super-priority liens." 

You original title report should identify the ownership as either fee simple or leasehold. That's your red flag or at keast merits additional dye diligence.

Here's what my mentors taught me many years ago: never have a loan in any position on a leasehold prooerty where the remaining term of the lease is less than ten (10) short of your maturity date. This will give you ample time to negotuatea or re-negotiate the lease terms you need in order to liquidate the collateral. 

It's also a great excuse to demand a co-guarantor with additional collateral to help your borrower when loss mit phase. You can thank me later for that tip.

Thanks so much for sharing this! 

I live in California; it is staggering how much some land leases are.  As far as I know they are mostly found in Orange County, around the beach areas.  So if a price sounds too good to be true, it probably is.

@Wayne Snell

 We have some land lease properties out here in CA as well and they generally sell for less than fee simple properties. When purchasing the properties, the most important thing to look at is when the lease is due to expire and, if the date is coming up, whether the land lease holder plans to renew it. I'm not familiar with how land leases affect note holders so I've got questions for you :)

Can you explain a little bit more about the land lease super lien? I assume that the heirs stopped paying the land lease fees. After a certain amount of time, the holder of the land lease will have the right to foreclose. If this is a super lien, then his lien will take priority over other liens (except property taxes) and when he forecloses he would wipe out your potential position as well as that of the HOA. Are my assumptions correct?

If so, did the land lease holder initiate foreclosure? Can a land lease holder FC or does he take back the leased land in a different way? Was there any way you could work out a deal ahead of time with the land lease holder to prevent FC? Or was the land lease coming to it's end anyhow?

In my hometown of Columbus, Mississippi a lot of properties have a 100-year lease that automatically goes back to the city upon expiration.  Most agents know to advise their clients of this but if you happen to be going it alone there could be a nasty surprise in store.

Medium apg houses 01Carey Dodson, Azure Properties Group, LLC | [email protected] | (205) 314‑4772 | http://www.APGHouses.com

Originally posted by @Andreas Mirza :

@Wayne Snell

 We have some land lease properties out here in CA as well and they generally sell for less than fee simple properties. When purchasing the properties, the most important thing to look at is when the lease is due to expire and, if the date is coming up, whether the land lease holder plans to renew it. I'm not familiar with how land leases affect note holders so I've got questions for you :)

Can you explain a little bit more about the land lease super lien? I assume that the heirs stopped paying the land lease fees. After a certain amount of time, the holder of the land lease will have the right to foreclose. If this is a super lien, then his lien will take priority over other liens (except property taxes) and when he forecloses he would wipe out your potential position as well as that of the HOA. Are my assumptions correct?

If so, did the land lease holder initiate foreclosure? Can a land lease holder FC or does he take back the leased land in a different way? Was there any way you could work out a deal ahead of time with the land lease holder to prevent FC? Or was the land lease coming to it's end anyhow?

Hi Andreas, I'm no expert on Land Lease Super liens by any stretch, but here is what my attorney told me. Land leases were an old way for condo developers 9at least in FL0 to quickly put up buildings without a huge capital outlay. They leased the land instead of buying it, and just financed the building. then as they sold individual condos, the buyer (in my case the borrower of the note I wanted to purchase) paid a monthly "lease" as part of the HOA fees, which was then passed through to pay the lease.

You are correct that the heirs stopped paying anything - lease, HOA or mortgage. The land lease lien is now available for foreclosure, although the property manager has not yet filed to do so. They told me that they would not accept a settlement, and would be filing a FC as soon as the unit goes to Tax Sale (effectively wiping us all out). I guess they want the unit, which is why I had to bail on the deal. Since it is a "Super Lien" they would take priority over my 1st position mortgage lien (one of the few that do - the other is the property tax lien holder). I've been hearing that in some states and Florida counties HOAs are now also getting super lien status, but I am not familiar with which yet - that might be something I research for another post.

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@Wayne Snell

 I wish more investors would post about pitfalls like this.  I have run across these in my DD as well.  I identified them on the simple 2-owner O&E level search product by looking at the deeds.  In these cases, the type of the deed is lease hold rather than fee simple.  I am curious to know if you look carefully at the last two deed conveyance images, is the type of title conveyed is not called out as lease hold?

Medium sure dark blue   dark grayMike Hartzog, SureMark Capital Group

@Wayne Snell Yep, must be one of the Century Village condo developments...."recreational land lease". The only developments I know of with these are the Century Villages. As for ordinary HOA/COA's obtaining super lien status, in Florida......not happening. There's been a lot of speculation/wishful thinking/ delusional thinking on that, trying to compare it to Nevada...not the same, not an issue.

Originally posted by @Carey Dodson :

In my hometown of Columbus, Mississippi a lot of properties have a 100-year lease that automatically goes back to the city upon expiration.  Most agents know to advise their clients of this but if you happen to be going it alone there could be a nasty surprise in store.

 Wow that is good to know Carey! I wasn't aware of that. While I have not yet purchased anything in MS, I do regularly see assets there so it is good information!

214‑620‑5057 | http://www.platinumventures.net

Originally posted by @Wayne Brooks :

@Wayne Snell Yep, must be one of the Century Village condo developments...."recreational land lease". The only developments I know of with these are the Century Villages. As for ordinary HOA/COA's obtaining super lien status, in Florida......not happening. There's been a lot of speculation/wishful thinking/ delusional thinking on that, trying to compare it to Nevada...not the same, not an issue.

Yes you are correct Wayne. It's one of the Century Village condos :) Glad to hear the HOA/COA super liens aren't happening. That would be terrible and cause a lot more harm than good IMO

214‑620‑5057 | http://www.platinumventures.net

Originally posted by @Mike Hartzog :

@Wayne Snell

 I wish more investors would post about pitfalls like this.  I have run across these in my DD as well.  I identified them on the simple 2-owner O&E level search product by looking at the deeds.  In these cases, the type of the deed is lease hold rather than fee simple.  I am curious to know if you look carefully at the last two deed conveyance images, is the type of title conveyed is not called out as lease hold?

 Mike thanks. No it is not even showing on the title report. I'm not exactly sure what the O&E company needed to do to "find" it, but I will definitely remind them going forward to look deeper!

214‑620‑5057 | http://www.platinumventures.net

@Wayne Snell

 Glad you avoided this. With a land lease holder eager to FC on the unit, you'd need to get that note at a deep enough discount to make it worth the time and effort to deal with all these problems.

Nevada is the only place I know of where HOA's have super lien status.

Uncommon things can create scares. That said it is important to understand here that the leasehold is ONLY entitled to the rent due. There is a tone after reading the HOA attorney's comments that some power above the power to collect the rent due exists and it does not. Rent is a fixed fee only adjustable every 10 years if provided for in the contract.

Without looking at the full spectrum of documents it is difficult to understand the origin of the leasehold. Did the developer take leasehold or did the HOA take leasehold. Usually there needs to be a fee simple interest 'anchoring' the leasehold.

Upon any action brought forward under the leasehold it is fundamentally treated like a mortgage interest. However a right to cure does not expire until the judgement is entered. Further, a claim made on a leasehold interest would have to state the amounts due which the defendant can place in care of the court and even contest said amounts due. The court can award the full amount due under the leasehold if they see fit.

None of this is to suggest that the OP should have played with something he was unfamiliar with; more like a don't be too scared if you see this again. To 'foreclose' means termination of a parties right to redeem. There always has to be a redemption ability. Any holder of any interest which grants a right to foreclose is only ever entitled to the amounts due under said contract.

Typically the O&E reports that many folks are purchasing for a loan purchase are one owner back in history. If you are looking at cooperative properties that is probably not enough. Go further back in time.  100 years might be overkill in some settings.   Usually going back to where the developer took ownership interest is sufficient.  Again, the leasehold needs to be anchored by a fee simple estate.  In this case, that could have simply been one or two more owners in the search.  These leaseholds are not uncommon in lots of states and they were, as mentioned above, used to minimize the cost of building the property which in turn lowers the potential sale price of the units.

They are not free passes to foreclose or obtain possession of units.  Many states protect against such ideas.

Awesome post! Thanks! :)