A lesson in the dangers of distressed property purchases…

A friend of mine contacted me the other day about a property investment opportunity that her brother-in-law (BIL) was placing in front of her and her husband. The property in question is located in the city and state where the BIL lives – and it’s far from the Seattle area at roughly halfway across the country. The house reportedly, and confirmed in the report I read, has a major mold issue that has attacked even the underlayment of the floors. (if you want to see some gross mold photos, check out this site) The buyer’s agent and BIL (who agent represents) are attempting to state that the water damage was caused by the former owner having a drug problem and not cleaning up after himself or perhaps because of a water leak in the bathrooms and from a leaking dishwasher. Hmmmmm…..

The house is supposedly being offered off-market at a lowball price of $400k for this tony neighborhood where $550k-800k is the common price points for various sized homes. Even the listing agent is nervous about selling the house with the mold issue but the owner is now deceased and the family can’t afford the home or to fix the home. This tells me that there is likely no insurance money to fix the problem especially if the insurance company deemed it to be failure of the owner to maintain the property. BTW – did most of you know that this is a common disclaimer in most insurance policies? If an insurer can point to an owner’s failure to maintain (ie. ignoring a leak) they can deny coverage. Also, as I’m learning, this particular state has had a rash of insurance companies choosing to deny the option of mold coverage in their policies at all… period because of prior mold problems that required huge insurance payouts.

Now, the price point initially sounds good but my personal concerns surround the mold issue, the fact that it has not been specifically identified in the mold specialist/inspection results, and the amount of work that actually needs to be done to get this house back in to the condition that this neighborhood typically expects. We are getting conflicting reports about the source of the mold and no one has sent my friend photos of the subject property to review. Also, there is the stigma associated with trying to sell a house that has HAD mold – and note I say “HAD” mold because frequently the average consumer can’t get past… well, the past. Agents are required to disclose known material defects, and so are homeowners (at least in WA State), so you’d have to tell a prospective buyer about the issue, even if it was fixed.

The BIL is a contractor and thinks he can replace the floors for about $20k and the only other item he thinks he needs to fix is a broken bathtub. Again, hmmmmmm……. Somehow I don’t think that this will be all that needs to be done.

His (BIL) expectation is that someone else will come in with the money to buy the property and he’ll do the labor and then they’ll split profits. I’m telling my friend/client that there is a lot more that needs to be sorted out and specified in a contract between the parties of the financial investor and the contractor (BIL). Thankfully, she agrees. On top of this issue there are questions of whether or not the house can be purchased with financing (likely not), what type of financing (preferably a renovation loan) is available, can it get insured, will it require oversight (it seems so based on the mold report) and by which entities (city, inspector, insurance, bank? most likely all of the above) and what it will cost to have re-testing done (what if it doesn’t pass?).

After even more phone calls today to the agent I have now learned that the listing agent is actually his secretary who has just gotten her license 2 months ago and that this is her first deal – ever. On top of this news, I also ferret out that the house is in foreclosure so we’re in a short sale position IF the $400k is even accepted. Wait, let’s recount the issues in a quick rundown….

1. mold problems that may or may not have had the water issue fixed.

2. foreclosure with short sale with proposed sale price at 80% of owed amount.

3. estate sale with unknown additional liens, taxes, etc. owed or owing. If the guy was truly a cocaine addict as desribed to us then there could be a lot more outstanding. Also unknown is who is actually selling the house: the widow, the attorney, the lender? Since it’s not yet foreclosed it’s likely the widow or attorney.

4. listing agent that works for the guy trying to be the buyer’s agent (MAJOR conflict of interest and not initially disclosed)

5. 1st time listing agent that has no other sales or negotiating experience working with a guy who has little, if no, experience in short sales.

6. unknown actual costs of repairs

7. no current photos available for review by prospective buyer (yet)

8. unknown lending environment for a distressed and damaged property

9. unknown insurance liability and potential to be an uninsurable property

I know what I think about this deal (a potential disaster) but I’d be curious to hear from others. What are your opinions? Would you go for it, and why? If you wouldn’t touch it, I’d love to hear your comments too.

15 thoughts on “A lesson in the dangers of distressed property purchases…

  1. Pingback: Team Reba Real Estate » For those hoping to cash in on distressed property…

  2. Being a contractor helps his situation a bit. It’s apparent the transaction will be a nightmare without complete divine intervention. Inconveniences and frustration is not reason to not go through with a deal though.

    But my advice…


    The listing agent being the secretary would be my one and only red flag needed to….. Run Run Run

  3. Hi Josh, his being a contractor *might* help it a bit but so far I am only aware of him being an HVAC guy which I don’t know really makes him an expert in cleaning up and repairing a mold problem. In fact, his commentary about what he thinks it needs to have done and lack of detail regarding how he’d fix the problem makes me want to tell the sister-in-law to run. There is a big cost overrun waiting to happen.

    Plus, with the short sale aspect there could be additional costs put in later when the bank decides (and they most certainly will) that they want more money. I’ve yet to see a short sale go for what the listing agent says it will go for in sale price. In fact, I have a belief that the people that work in loss mitigation for banks likely come from the adjuster positions at insurance companies.

    All of the financial issues will cause the investor to potentially lose yield or capital on the project. God forbid that the house end up taking $100k to repair, take 6 months to complete, and then sit for 6 months to a year on the market only to be sold for $550k instead of the $650k the buyer’s agent is hoping for. That wouldn’t be a prudent investment even if you could use OPM (other people’s money) for a loan.

  4. I assisted a buyer in purchasing a “mold house” years ago that looked at least as bad as some of those photos in the link. The buyer approached me to buy that particular house just as your friend is. The house was not listed for sale and was a vacant property. The owners filed bankruptcy and moved out of state. There was no mold or anything wrong with the house when they did that.

    After they left, the water in the upstairs toilet tank froze solid and the tank cracked. The water ran from the toilet for weeks all the way down through the house and out to the street before a neighbor saw it and called the water company who shut the water off. The mold grew as a result before the buyer approached me to buy it.

    If his plan was to fix it and sell it, I don’t think I would have agreed to represent him. He saw this as an opportunity to get a great house, it was a custom built home that was less than five year’s old, for $.40 to $.50 on the dollar. He was looking for a home for his family, not as an investment. It was a way for him to get the best house for his family that he could no way afford if it didn’t have the mold problem.

    Mold is like tooth decay. If they don’t get it all out it will continue to grow and it can turn up again and again in places where you thought you killed the mold. For that reason I don’t think it makes a good flip project. Would be hard to get someone to pay top dollar after the improvements, and still hold him harmless if the mold should reappear somewhere down the line.

    It may be worth the risk to your friend, but what about the person who buys the house from him after he “fixes” it and resells it? Just like Extreme Makeover often determines, some houses are better torn down. The house would have to be pretty special to try to salvage it from extreme mold issues. In my client’s case it was. But if the house is an old and obsolete floor plan in a great neighborhood, maybe it should sell for lot value and be torn down, to avoid the risk of future health issues to subsequent buyers.

  5. Take pictures of the mold problems, present them to the lender, and yoru short sale offer might just get accepted at an amount less than the $400k level. That’s one thing mold is good for.

  6. It would be hard for me to recommend that a first time investor buyer use the services of a real estate agent who is brand new, to help negotiate a short sale, one of the most challenging, complex type of transactions around.

    With so many homes on the market to fix and flip, why THIS home?

    I would be wondering what incentives (disclosed or undisclosed) were being offered to the agents to sell THIS particular home.

    Wait a minute, how could the home be “off the market” and also have Realtors involved?

  7. Jillayne,

    The mold house I “sold” was not on the market. Often if the house is in tremendous distress, it is a health hazard and not “marketable”. The liability for the owner and bank of people getting hurt while viewing it, or getting sick from the mold, is too great to “list” it for sale with a lockbox on it. Since I represented the buyer and not the seller, a “REALTOR” was involved without it being a property listed in the mls. I can’t answer to Reba’s specific house in the post, but the similar one I sold was off market.

    I did what Melanie suggests in comment #6. I sent an offer with many pictures of the mold to the lienholders. They opted to sell it short vs. taking it over and putting it on market in that condition for liability reasons.

  8. Pingback: RealEstateUndressed » Blog Archive » Magnificnt 7 - 2007

  9. Pingback: Cavalcade of Risk - January 2, 2008

  10. Pingback: Are distressed properties really a good deal? « YsGuy.com Blog

  11. Interestting that WA’s new Distresed Property Law (effective as I recall last July 1) isn’t even mentioned above, even though you state that house is in foreclosure.

    This tough new law makes it clear that anybody knowing this and proceeding to make an offer or deal with the Owner/Seller is his FIDUCIARY, meaning Seller’s agent with duties galore to that Seller….and humongous penalties to the Buyer/Offeror or his REA ignoring such law

    WA is one of 8 or so states to enact such DPLs in last year or so and there’s a national push on by the AGs Association to enact such laws in all 50 states.

    So anybody interested in this distressed property or any other, in any state would be advised to do some research and see if that state has enacted a DPL and if, be in full compliance with it.

  12. Actually, John, if you read the beginning of the post thread you’ll see this article was written BEFORE the law went into effect, which was June 12, 2008, and I also was referencing a deal that was in a different state. It was actually a house in Texas but my client/friend lives here and was asking my advice on whether it looked like a feasible investment for her and her husband. I told her to get away from this deal as fast as possible.

    Keep in mind that the Distressed Property Consultant law is fosued specifically toward homes that are in foreclosure and that have equity positions. It also was drafted to stop those cases where buyers of foreclosures were promising homeowners to save them from foreclosure and to allow them to stay in their homes. In a lot of those cases there was equity skimming and it was the intent of the law to stop this practice. In its actual implementation it got mangled by the legislature and ended up harming more people because agents and potential buyers of these homes in distress decided to walk far, far away from purchasing them. The exact thing these homeowners needed. The legislature has been inundated with comments from people on all sides of the fence on this issue and is currently drafting a revision that is expected to be released within the next couple of months and that will be put into effect immediately. We’re all (at the Association of Realtors) looking forward to seeing the new verbiage passed as long as it clarifies more reasonably the duties of the individuals involved.

    I am in agreement with you that any RE agent or consumer be in compliance with the local and state laws that affect their area.

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