Articles for the Cash Flow Business

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War Stories From a Cash Flow Note Veteran

War Stories, battles won battles lost, and some you wish you had never started. Every industry has them and the cash flow industry is no exception. At the last two conventions I have facilitated a session entitled, “Become Your Own Investor! Real life stories of money made and lost buying notes.”

After divulging a few horror stories followed by some enticing jackpot stories, I am always thrilled to glean knowledge from the experiences shared by others in the audience. Recognizing the value of learning from real life experiences, a participant in the last session suggested we run a series of “war stories” from industry professionals including their strategies to overcome the obstacles. Continually searching for fresh writing ideas, we are going to kick off the “war stories series” with a horror story from my personal archives. We have recruited several other note pros to share their stories in upcoming issues and we encourage all of our readers to submit their personal experiences.

The transaction was submitted for review in December of 1999 and started out as seemingly ordinary. It was a 1940’s bungalow style home in a small Oregon town that was occupied by the payer. The payer had very poor credit and medical collections however; a strong verifiable pay history and a fair amount of equity offset credit. The transaction details follow:

Sale Date: 10/10/96
Sale Price 45,000
Cash Down 5,000
Original Balance     40,000
Rate 10.0%
Term 180 payments of $429.84
Payments Made 26
Current Balance 37,128.94 with next payment due 1/1/99

 

Our offer of $31,250 was accepted and we proceeded using standard due diligence procedures. We reviewed copies of documents, a title commitment, the pay history/account verification from the third party servicer, and a new appraisal reflecting good property condition and known value increases for the area resulting in a fair market value of $60,000. We prepared for closing and required standard proof of hazard insurance. The seller returned the document package along with the insurance information. We called to verify coverage, which was verbally confirmed by the agent, and we authorized the wire transfer to the seller.

Now it gets interesting. On the day the wire transfer was authorized at the bank (a Friday) we received a return call from the insurance company stating they were in error and due to non-payment the hazard insurance policy was no longer in effect. This was brought to my attention by our closer and we attempted to contact the buyer but were not immediately successful.

During my 10 years of corporate experience and at that time two years of personal investment experience, I had seen thousands of accounts purchased without insurance verification and felt the risk was nominal. I decided to proceed and did not pull the wire at the bank. We sent the standard letter to the buyer to clarify the insurance issue and planned to force place insurance if sufficient proof was not provided.

Things seemed in order until we were contacted by an adjoining property owner the next week making a $10,000 “as-is” offer to purchase the “lot” next to their $250,000 home.

Guess what? The house on which we had purchased the note burned down over the weekend and we were left with nothing more than a lot, a shell of a building, and debris as security.

We called the fire department (to verify the date of the fire and the condition of the property), ordered a property inspection, contacted the appraiser to obtain a land only value ($24,000 – $29,000), and traced the buyer whose home phone was no longer in operation.

Once we made contact with the buyer we confirmed our fears finding he did not have insurance as the insurance premium money had been used to purchase prescriptions for his recently deceased wife who did not have health insurance coverage during her fight with cancer. He was a self-employed car mechanic and his income was currently down. It was a sad situation and initially the buyer seemed cooperative and wanted to continue payments until he could sort out his financial affairs. He was interested in placing a mobile home on the lot and hoped we would help finance it. We were happy to explore the possibility and asked for a show of good faith in the form of current payments during the interim. Unfortunately the buyer’s financial situation declined, payments were never received and we ended up holding a Deed in Lieu of Foreclosure which we waited to exercise until we knew our final course of action. We attempted to sell the lot but realized most new building activity was being done on small tracts of land outside the city limits.

The neighbor was a local businessman who owned a nicer home in this small bedroom community of mixed homes. He was unhappy with the condition of his neighboring lot and increased his offer from $10,000 – $15,000. We explained it was appraised for $24,000 – $29,000 and were not ready to take such a loss but did offer owner financing if we came to an agreeable price. He did not desire financing and was concerned over the view. Understanding his motivation, we explained we were considering the placement of a used single wide mobile home on the lot (1969 or newer according to zoning requirements) which we would offer to a new buyer with owner financing if we were unable to sell the property as a lot. We waited (or I should say sweated) the situation out and the neighbor offered a cash purchase price of $23,000 provided the lot was cleaned. Initial estimates for clearing the lot had come between $5,000 to $7,000. We contacted the fire department regarding their “Burn to Learn” program. The fire department agreed to arrange a practice drill on the property resulting in a complete burn of the remaining structure and approximately 95% of the debris. The remaining debris could be hauled away at a nominal expense. We accepted the neighbor’s offer resulting in a loss after expenses of approximately $10,000. The transaction closed and I was never so relieved to have lost “only” $10,000.

So, what did I learn?

  • First, don’t be rushed or pressured into making investment decisions.
  • Second, we perform verbal debt verifications with the purchaser even if the account is serviced through a third party servicer. In the past we were comfortable with the servicer’s pay history but now I attempt to obtain all information available from the buyer prior to closing.
  • Third, we require current insurance at closing even if the seller has to pay and obtain insurance on the buyer’s behalf from the note proceeds. We have immediate forced place insurance policies in effect and we have back-up blanket coverage in case something is overlooked.

I have discussed this with numerous investors who have stated they’ve taken similar risks with insurance without detrimental effects but knowing it is a fixable problem we have implemented these procedures unless the land value far exceeds the investment.

As a follow-up to this story, just last week we were ready to fund on an Alabama note that had a current insurance declaration page in the file but upon calling we found the buyer’s had not kept their premium current and coverage had lapsed. We delayed the closing and required proof of current insurance prior to funding. We called to follow-up several days later only to be told the house had burned down the night before! It was another sad story but a good reminder and all the proof I needed to make certain we confirm insurance coverage at closing and during the life of the account. Live and learn or better yet listen and learn from my mistake!

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