Do Diligence, Part II
By Vena Jones-Cox

A few months ago, I wrote an article about the importance and process of completing due diligence on properties before you buy.

This week, I’m going to share a recent adventure in due diligence on a package of defaulted notes that I was offered recently, and what I was able to discover simply using free internet resources.

This package consisted of five local notes. I know that many of you have studied or are at least interested in non-performing notes, but for those of you who haven’t, let me say that the IDEA of buying a defaulted first note is this: if it “reperforms” (that is, you can make a deal with the borrower to modify the loan at a lower payment, and the borrower actually makes those payments), the returns are humongous. If it doesn’t (that is, the borrower will not communicate with you, or doesn’t want the property, or can’t make the new payments), you want to have paid little enough for it that if you have to foreclose and get the property, you haven’t spent more on the property, in total, than you would have paid had it been a simple real estate purchase transaction.

So what you need to know before buying a non-performing note is a series of things:

How much is the property worth? In many non-performing note situations, even when the mortgage is in first position, the property is worth much less than the debt against it. The current value of the property, along with the back taxes, condition, and costs of foreclosure, tells you how much of a discount you’ll need to make money.
How much are the back taxes? Even if you’re buying a “first mortgage”, real estate taxes always supersede your position—in other words, they MUST be paid, and they will be paid FIRST in a foreclosure situation . They become part of the purchase price of the note, whether the borrower stays in the property or not, simply because you must pay them to acquire the property or keep it from being auctioned off out from under you.
Is the property occupied? If so, does it appear to be occupied by the owner, or by a tenant? Vacant properties rarely “reperform”—if it was the borrower’s primary residence, he’s moved on. If it was a rental, it’s not producing income and is likely to need work.
What condition is the property in? One of the cardinal rules of note buying is that you may NOT approach the borrower until you own the note, so determining condition is difficult. The best you can do is drive by and look at the exterior condition and check any recent MLS listings of the property to see if condition is noted; in addition, you can check for orders against the property with your city’s building department
What does the borrower’s legal life look like? A check of the county court records will tell you if he has other foreclosure, liens, garnishments, etc. that could affect his ability to reperform, or could represent additional liens against the property that would force you to foreclose to get clear title rather than accept a cheaper, quicker deed in lieu of foreclosure from the borrower.
So with this background, I started the due diligence on these 5 notes. All the research I did was free, and it took less than 6 hours to find out everything I needed to know about these deals.

Notes # 1 and #2
The first place I looked was my local tax assessor’s website, to determine the amount of the back taxes. And the first thing that I NOTICED was that the owners of these 2 properties were not the same as the borrowers whose names appeared on the spreadsheets. Both properties were sold in 2012, despite the fact that the mortgages were issued in 1997 and 2003, respectively.

Suspicious, I went to the transfer tab and discovered that the seller in both cases was “land forfeiture sale”. A quick check of the legal records showed that both properties had gone to tax auction in 2011, failed to sell, been forfeited to the state, and then been sold by the state to the current owners.

In other words, THERE WAS NO MORTGAGE TO BUY. The lender’s position was wiped out in the state forfeiture. Yes, that’s right, I was being offered a first mortgage that no longer existed. Next.

Note #3
At the tax assessor’s website, there was a great big red banner that said, “tax lien issued”. This means that someone had, at some point in time, purchased the back taxes (and therefore the right to collect them at 18% interest per year). A call to the tax assessor’s office revealed that the amount of the lien that was purchase was $12,000—more than the value of the property—and that the property was scheduled for tax lien sale (which will, again, wipe out the mortgage) in 6 weeks. Since I could not pay even the $12,000 for the property, I deleted it from my list.

Note #4
The spreadsheet said that this property was a single family home. The tax assessor’s site said it was vacant land. A double-check with the note seller confirmed that the spreadsheet was wrong and the tax assessor correct.

Normally, I do not buy vacant land, but this particular parcel is in a semi-rural area with actual land sales nearby. So I dug a little deeper to see if it was worth pursuing.

I went to the court records to look up the borrower. Turns out he owns a construction company and the house adjacent to this 2.5 acre parcel. That’s good news: he probably needs the land to store equipment, and might want to keep it at a lower price and payments. The bad news: he is also in foreclosure on his house next door. Named in that foreclosure suit are: the IRS, to whom he owes $250,000; the state of Ohio, to whom he owes $100,000; the state of Ohio department of human services, where he has a $50,000 child support lien.

The picture this paints to me is that 1) he’s going to lose his house, which means he won’t need the land; 2) I will have to foreclose on the land to rid the title of all of these liens; 3) then I’d have to wait 6 months to sell it, because these particular lienholders have the right to come back and reverse the sale for that period of time; 4) after 6 months, I’ll have a 2.5 acre parcel of land that’s most useful to the next door neighbor, and heaven knows when there will be a next door neighbor again. Next.

Note #5
The tax assessor’s office reveals that the property is still owned by the borrower and that the back taxes are a mere $3,500. Yay.

Comparable sales say that the property is worth around $25,000 as a quick sale price. Yay.

The court records show no other foreclosures or lawsuits against the borrower. Yay.

A driveby of the property shows that it is vacant, vandalized, and best of all has city orders nailed to the door. A call to the city building department reveals that there is a hearing to tear down the property due to its extremely poor condition—and that hearing is happening THIS WEEK.

My assessment: the borrower will not be interested in keeping a property in terrible condition, and it could well be torn down before I get ownership of the note, a quit-claim deed, and thus the right to argue with the city about tearing down “my” house.

Yep, this note package was 0 for 5 in terms of what any investor (who actually cares about making, rather than losing, money) should consider buying at any price. Yet my experience tells me that some investor somewhere WILL buy it, on the theory that at least some of them will “work out”. Anyone could do the same due diligence I did, yet some out of town buyer who thinks that one “can’t lose” at $2,000 a note, will.

Reprinted with permission of Vena Jones-Cox. To get more free articles and tips, subscribe at www.TheRealEstateGoddess.com