EVEN CONSIDER BANKRUPTCY!
(An excerpt from "Creative
It may be a bit of a morbid subject, but the fact is that
there are a lot of investors out there that have been
hurt by the circumstances of the last few years.
Countless investors have called me for my advice on what
to do about their problems. A sad sight is seeing someone
go down the tubes financially - especially when it could
be avoided. Negative cash flows, vacancies, credit card
debt, and even negative equities are not a hopeless
situation. Some of the causes of these problems are:
vacancy or long term vacancy
- Paying too
much for properties
repairs or damages
are not terminal. There are at least 27 cures other than
bankruptcy and foreclosure. Don't give up. Almost any
disease can be fatal without the medicine to treat it.
Hang in there and give the doctor a chance.
How to recognize a problem:
- You try to
get MacDonalds to take VISA or a note against one
of your properties.
mailman is getting back trouble from the weight
of all your bills.
- You hate
to check the mailbox or play back the messages on
your answering machine.
banker steps into the nearest office or picks up
the phone when he see you walk in the door.
makes up a large portion of your food budget.
starting to get some stinkin' thinkin' and
hardening of the attitudes.
- You think
about your rental units every time you light a
match or see a fire truck.
- Your sob
stories can beat those of any of your tenants.
learned how to pull cash out of the purchase of
properties and live from purchase to purchase.
- You start
looking around for appraisers that appraise real
That may be a
little exaggerated, but maybe you get the point. I
counseled one investor that was surviving by buying items
or gift certificates on his store charge card and then
taking them back for cash. Another had 100k in debt and
hadn't had a job in 4 years. He lived off of his mother's
Social Security check. Others are on the verge a nervous
breakdown or have turned to alcohol.
One case I'll always remember was an investor that was
not sure where the next week's food for his family would
come from. I was excited to look at his portfolio and the
potential involved. Using some simple techniques (that
few people know) it is a simple job to restructure his
portfolio and change his cash flow situation to the point
where he could retire (primarily using the principles of
"Equity Arbitrage" and "The Discount
Another case was an investor that came up to me after I
spoke to an investor group in Denver. He waited around
patiently until everyone was gone and had the most
dejected look on his face. He had a condominium that had
gone down in value way below the mortgage. He had good
credit, yetcouldn't afford the negative cash flow or to
sell the property. This was his only major problem, yet
he could see no other option besides bankruptcy. It took
just a moment to prescribe the medicine that would clear
up this big financial wart. Let's look at his particular
The property was originally worth $70k and he had a loan
for $60k. The value had dropped to $50k, so he was in a
negative equity position. He owed ten thousand dollars
more than the property was worth. This loan is to a bank
and would foul up his credit if he let it go back. The
bank didn't want it and threatened suing for a deficiency
judgement if it went to foreclosure.
STEP ONE - talk to the lender
If the bank had to foreclose, what would their situation
be? If the value is $50k, they would probably end up
taking close to a $20k loss on their $60k loan. Their net
proceeds after the sale might be $40k or less. The first
part of the remedy was to go see the banker with the
words "I'd like to talk about OUR problem." The
banker may need it pointed out that it is his problem
too, because he could be looking at a $20k loss. "Mr.
Banker, I think there is a solution where we could avoid
this." One thing to remember is that the banker does
not like losses, cannot afford foreclosures and may be as
concerned about a possible foreclosure as you. Ask him
how he feels about the security for his loan and inquire
if he would like better collateral. Present to him the
possibility of him substituting collateral provided it
meets his approval and puts him in a much better
situation than he is in now. If approached in the right
way, most bankers will listen.
STEP TWO - find the collateral
Ok, so how do we find this other collateral and what good
would that do us? Most real estate investors and
professionals are only vaguely aware that there is a
"discounted mortgage" market. The basis of this
market is the purchase and sale of privately held
mortgages secured by real estate. These mortgages are
generally created in the sale of a property between two
private parties and sell at a discount at a later date.
These discounts range from about 25-50% depending on the
terms of the note (primarily dependant upon the length).
In other words, a $10,000 second trust deed secured by a
nice piece of real estate might sell for between $6,000
and $7,500 in the discounted mortgage marketplace.
What this means is that in the discounted mortgage market
you can find a privately held note that is similar to the
$60,000 loan with the banker and buy it at a substantial
discount. At a 40% discount $60,000 in notes could be
purchased for $36,000. In other words, using the "DiscountedSubstitution"
technique, it is possible to pay off a $60,000 loan for $36,000.
STEP THREE - find the financing
That sounds well and fine, but how does one obtain the
cash needed to buy the note? If the lender agrees to take
another note as collateral then the original property
will be free of that loan and the funds could be obtained
by financing that property. That means that the
condominium that had the $60k loan is free and clear when
the lender substitutes collateral. The $36k that is
needed to buy the note could easily come from putting a
new loan on the condominium. Ok, why would the lender do
the deal and how is someone that is in foreclosure going
to get a loan?
There is a bit of a catch 22 situation here. When the
loan is behind in payments and foreclosure is pending,
the banker may begin to be flexible enough to listen, yet
the owner's credit and financing ability may be limited.
If the loan is current and everything is fine at this
point, the lender isn't too worried, yet the owner's
financing ability is not impaired.
I have had lenders tell clients that they are not worried
and won't discuss any changes, because they know they
will make the payments. One client is a dentist and the
lender just has this euphoric feeling of "I know
he'll make the payments" when the loans are actually
The benefits for the lender are plenty. Whether the loan
is behind or not, it is a bad loan and a tremendous
potential problem for the lender. The property is over
leveraged, has a ridiculous loan to value ratio and is a
potential $20,000 loss for the lender. It is easy to show
him that the newcollateral is so very much better. Since
it is only a substitution of collateral, the current
borrower is still responsible, yet now it is a self-liquidating
loan which bankers like a lot more than emptycondominiums.
There is a different, more valuable property as
collateral and the loan to value ratio is dramatically
If getting the loan is a problem, there is plenty of
profit margin to allow bringing in an investor to help
finance the deal. A potential loan of $40k is possible
leaving money for any points and a couple thousand left
over to give an investor. There will also be $10,000
equity in the property after the transaction takes place.
It could even be possible to give the investor some of
that equity also. I'd love to tell you how tomake a
continued profit of $20,000 each year from the note that
the bankerhas as collateral, but I don't have room here.
STEP FOUR - substitute collateral and refinance
All of these steps could all close at one time. The
purchase of the note, refinance of the property and
substitution of collateral can all close at the title
company on the same day. The results are exciting for all
concerned. Every party to the transaction wins:
owner - Prevents foreclosure, turns a $10k loss
into a $10k profit, makes the property saleable,
has a potential $20k/yr continuous profit.
- Lender -
Averts a foreclosure and bad loan, obtains better
collateral, saves a client, probably gets a
promotion for "his" ingenuity.
- Investor -
Gets a good property, cash, equity, good
collateral and a good deeds merit badge.
STEP FIVE - get up and start running
Time to change the attitude, move on and be focused on
profits not problems. If there are other problems yet to
be solved, take a renewed determination and optimism into
solving the next one. What happens when your problems are
solved? Do you think the banker has other problems? You
could make $10,000 equity and $20,000 per year in cash
from every other similar condominium out there. In
addition, a version of the same principle works well with
a lender's REO property.
I used to bend over backwards to try and buy properties
at market price with easy terms. Since the time I learned
about real estate paper, I haven't had much of an
interest in a property unless it was less than 70% of
market value with nothing down and cash in my pocket.
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