Yes, it's true, you can get rich investing in real estate (ask Donald Trump). It's also true that real estate can make you broke, and worse. I know, everyone is telling you to buy real estate, and you're hearing only the positives. But before you head down that path, at least hear some negatives, then proceed with caution. Before you start buying rental properties (and I'm not trying to discourage you, well, maybe a little), ask yourself this question: is there anything worse than losing everything? Answer: Yes, there is. And that would be, losing everything and more. In other words, after they've taken it all, the hounds are still after you for more, and more, and more. And the nightmare never ends. That's what can happen in real estate.
I know, you think that if things get bad, you can just let a property go to foreclosure, the bank auctions it off or takes title as an REO, and you're done, you're square with the bank and the nightmare is over.
Well, maybe. But what if you live in a recourse state? In that case, if you owe the bank $100,000 and the property auctions off for $75,000 then guess what, you may still owe the bank the other $25,000 and they can sue you for it if they choose. That's called recourse. That is, the bank has recourse against you for the underage. Your house is gone, yet you still have to pay.
Here are some other details about recourse: In some states banks do not have recourse for purchase money (original mortgage) but do have recourse if you have refinanced. That's an argument against refinancing.
Also, in some states, the bank can choose a trust deed foreclosure (fast but no recourse) or a judicial foreclosure (slow but with recourse). This is scary stuff.
And then there is a quarky tax issue: Assuming the bank does forgive the underage, they could, if they are in a nasty mood, 1099 you for it. In other words, they'll take the loss, but they want to deduct it. But now their loss is your gain. Since you've been forgiven that underage, that's considered income to you and so you have to pay income tax on it. I'm not saying any of this will happen to you, I'm just saying it could.
And of course there is the ever-present threat of law suits legitimate and frivolous. I've been victimized by two frivolous law suits, one I ducked and one I didn't. Did you know that if a burglar cuts his hand on the glass he broke to get into your house he can sue you? That's how ridiculous the law has gotten.
So, how do you protect yourself? There are asset protection attorneys who will tell you that you need an LLC or a corporation to hold title. And I'm sure they're right. But here's the problem: You're trying to be a real estate expert and not make mistakes, but now you have to also be an expert on asset protection and not make mistakes there too. Do you domicile your LLC or corporation (C or S) in Nevada or in the state you live in or somewhere else? Do you pay taxes up front? Do you need permits or licenses? How can you guarantee that your entity can't be pierced? You can't. Anything can be pierced. There is so much to do and it has to be done right, or else. This is why I leave real estate alone and invest in the stock market instead. In the stock market you don't have to worry about any of that, you only have to worry about two things: winning and taxes. But liability is never an issue.
Another problem that may blindside you is the fact that banks do not have to foreclose! And here you need to learn the term Zombie Property; that is, a property that you cannot get rid of by any means but sticks to you like super glue to the day you die.
Is that so bad? Well, suppose the property is unsafe and you're afraid to put a tenant in it, so it makes you no money. But the mortgage debt continues to grow. And the city sues you for unmowed lawn, or unshoveled snow, or a broken water main, or just for the fact that it's an abandoned property. Suppose the city demands that you fix everything or tear it down. Well, a vacant lot could be preferable, but what if it costs you $30,000 to tear it down because it's a 4-plex with asbestos? You get the picture? Yes, things can be worse than losing everything. You can lose everything and much more.
How I Got Out Of a Zombie Property
I had just such a property in Buffalo, New York. I won't bore you with how I got into the mess except to say that I was caught by three realities: (1) rents were half what I thought they’d be, (2) maintenance cost was twice what I thought they’d be, and (3) tenants steal. Tenants stole my copper pipes (twice), they stole my boiler, one even stole my power meter. Why? What use was it? I have no clue, but someone thought they had a right to my meter. Go figure. And then there was the ongoing cost of eviction. Every three months I had to evict some deadbeat tenant who no doubt thought I was a villian who deserved not to be paid.
Anyway, over three years I did not enjoy a positive cash flow in any month. I was wiped out and things were getting worse. I had ten properties, nine of them I managed to sell, but one of them no one wanted. It was my zombie. I had no choice but to let it go to foreclosure. But the bank would not foreclose. They didn't want the zombie either. But they were still on title so I could not sell the property even to an interested buyer, even for nothing I could not even give it away. That's the nastiness of it. And yet the bank was harassing me to pay off the loan with money I did not have.
So, what did I do to get the bank off my back? The only thing I could do: I filed BK-7. That stopped the bank from chasing me and reduced the amount owed to zero. But guess what. The bank was still on title so I still could not sell or even give away the property even though the balance owed was zero!
One attorney advised me to file a Quiet Title Action. The reasoning was simple: Since the balance owed is zero, the bank has no right to maintain its lien. If I won, a judge would force the bank to release its lien and I'd finally have control of the property. But another attorney advised against it. He reasoned, what if the judge ruled against me? He could interpret my Quiet Title Action as reasserting my interest in the property and set aside my BK-7, and thus the bank could reassert its collection interest against me. I couldn't take that chance so Quiet Title Action was out of the question.
So, what could I do? Here's what I did. I refused to pay any city fees. And eventually, two years later, the city foreclosed, and the city foreclosure would, I knew, trump the bank’s interest and wipe it out.
But what if no one bidded at the auction? Would the city take title like a bank REO or not? Actually, not. Cities, unlike banks, do not take title of REOs. If no one bids, the city just waits another year and tries again at the next auction. And during that year, you still own that property, and its liabilities, and its accumulating taxes, and its grief. To draw bidders, I was considering advertising the auction. I was even willing to pay someone to take the property off my hands. But then something good happened. A few weeks before the scheduled auction, I received a letter from the bank they released the lien! Woopee! With the lien gone I quickly sold the property to a willing buyer who paid the taxes and fees due. Bless his heart, and I wish him all the best. Why did the bank release the lien right then? I can't say for sure but I'm betting that the city notified the lien holder that their lien was about to be wiped out by a government auction, and that got their attention. Or maybe the city killed the bank's lien. Whatever happened, I'm glad it did. And when the property was gone, I felt a freedom I hadn't felt in a long time. But what if the bank had not released the lien and the property was not bought at auction? I shudder to think of it.
Now, one thing that I did do right was: when the buyer bought my property, I insisted on a hold-harmless sentence in the contract. I knew that “as is” means nothing, and failure to disclose defects can get a seller sued. I didn’t want to get sued for anything that might be wrong that I didn’t know about, therefore, without hold-harmless verbiage I dug in my heels and would not sell. I’d rather take my chances at the auction. The attorney balked, the buyer balked and promised, “Oh, I wouldn’t sue you, I promise.” Yeah, well, I know from sad experience that when someone promises not to do a bad thing to you, that is exactly what they intend to do to you at their earliest opportunity. In the end the buyer caved and I got my hold-harmless wording, and I slept well that night knowing that if, for instance, the next snow broke the ridge beam and the roof caved in, the buyer could not sue me.
I still think about what might have happened during those years. What if a burglar had injured himself and sued me? What if druggies moved in and turned it into a meth lab? What if the house caught fire and burned down half of Buffalo? What if a severe snowstorm collapsed the roof? Well, those things didn't happen and now the nightmare is over. But for thousands of other real estate investors, that nightmare continues. Invest in real estate? Not me. Never again.
What Should Happen
Should any bankruptcy judge read this, here's what I think should happen.
First: Lien holders should not be allowed to maintain valueless liens against real property. BK-7 should not only reduce the debt owed to zero but should also require lien holders to release their liens so that the bankrupt owner can get rid of the property by some means.
Second: Even without a BK, if a lien holder will not foreclose in a certain reasonable time (say, one year from the Notice of Default), then a court should declare the lien valueless and void, and therefore must be released without the owner having to resort to bankruptcy. In otherwords: banks, foreclose or not, but decide. You ought not to be allowed to be a perpetual ball and chain around someone's neck preventing them from getting rid of a property. If you don't want the property and are unwilling to foreclose, fine, but then go away.
Third:When the lien is gone (by BK-7 or some other means) the owner should be allowed to escheat real property to the state, and the state should have to accept it. This is not unreasonable. After all, what happens when a person dies intestate? If no heir accepts title, the state must. Why should someone have to die to get relief? That's what bankruptcy is for, to allow people a fresh start. Part of that relief should be to unload abandoned, zombie properties. And besides, the state is a taxing authority that charges you property taxes that you must pay. Well, that taxing right of the states guarantees certain reciprocal benefits to you the property owner like water in the pipes, like fire and police protection, etc. I'm saying that one more benefit ought to be this: Since the state can tax you, you should have the right to excheat (transfer ownership) of abandoned properties to the state, assuming all liens are cleared. It’s only fair. If you, the state, has the right to tax my property, than you’re exercising that right ought to give me the right to give you the property in lieu of taxes.
That’s how I see it.
An Outragous Idea
Here's a thought about how to get rid of a zombie property. I don't know if it would work, and I'm not suggesting you do this (so you can't sue me), it's just a thought. Maybe some clever probate attorney could make it work.
Suppose you desperately wanted to be rid of a zombie property and were willing to pay someone to accept title. But no one wants it. Except maybe, suppose you found a man who had only three months to live. And all he wants is to go to heaven and leave his children with a little money which he doesn't have. Maybe if you paid him (his children) a few thousand dollars, he'd take title to your property. Then when he dies, the state has to take title. Doesn't it? After all, no heir has to take title. When the probate dies, so does the title. Doesn't it?
Well, it’s just a thought. If anyone every actually tries this, I'd like to learn how it turns out.
Real estate can make you rich, but it can also make you poorer than you can imagine. Why? Because it is fraught with liabilities. Is there another investment that has no such liabilities? Yes, there is. The stock market. In fact, that is the very definition of stock, investment without liabilities. Yes, you can lose money in the stock market, but you can never lose more than everything, something that cannot be said about real estate.