CONTRARY TO SOME of the books, seminars and infomercials, there are many ways to get burned in real estate “paper” investment. Unfortunately, there are many people out there with a “churn-em and burn-em” attitude. The good news is most of the areas of risk can be covered with some basic business savvy and common sense. I am distressed to see some of the areas and circumstances of loss that have been happening. Most losses you may have read or heard about did not need to occur.
The entire area of risk management is an extensive subject. Little has been written other than by Lorelei Stevens in her book “Lorelei's Legal Lessons.” I sincerely believe that no one should even consider paper investment without reading her manual. It's that simple.
I looked at over 800 pages of my books and seminar notebooks a while back and realized, that “strewn” throughout were war stories and tips and techniques for risk management that were valuable, but too disjointed. I decided one of the most valuable contributions I can make to the industry is to organize and share this material. I'll start today and share monthly while I flesh out the material.
There are three main categories of risk. In The Paper Game. I termed them…
The 3 P's of Paper
- The People
- The Paper
- The Property
I am going to start by addressing some of the common “scams” and problem areas that seem to be causing losses currently. I'll only have space to cover some of the highlights. I'll look at some of the potential “profit viruses” out there and some of the potential “vaccines” to protect you. Some of the “People” risks are:
The facts of life are that there are people that will lie, cheat, steal and even kill to get ahead or to gain profit. You are only safe in this business or almost any other by assuming that people are out to get you. It's like riding a motorcycle on the streets. I used to assume as long as I was on both wheels, going the speed limit and not horsing around, I would be fairly safe. When a little old lady tried to turn me into a hood ornament, my viewpoint changed – as did the curvature of my neck. Now, if I drive on the streets, I assume that incredibly stupid maniacs are out to get me. I avert many accidents by expecting the unexpected. You have to do the same in business.
Vaccine #1: Assume the potential for fraud. Do your “due diligence” no matter what. Don't succumb to the ease of accepting information someone else provides. Build a team of experts and resources to provide objective, independent verification of facts. It can be nearly impossible to “burn” you if you follow some of the simple and safe ways to verify details and information on a note.
I have seen almost any document faked, altered or falsified. You must verify everything. When I make the statement that I buy “paper,” I am referring to a concept. I don't buy the documents that someone gives to me. I “assume” they have been altered or falsified until I prove otherwise. Simple verification phone calls or research can make all the difference in the world.
Vaccine #2: Verify all documents, facts and figures. Look at the potential consequences if a particular document were not correct, real or legitimate.
I'm looking at an MAI appraisal right now from one of the most respected appraisers in our area that I know has been influenced in several ways (the appraisal has been influenced, not him). The representations from the owner of the property concerning zoning, development, potential purchase offers and comparable sales have boosted the value.
On the other extreme, there are incompetent appraisers, appraisers who will be bought or can be outright deceived. My version of the “hood ornament” scenario in paper investment came from a little old lady that presented me with what I refer to as “appraisal du-jour.” She had taken an existing appraisal for the amount needed (on a different property) and “whited out” the subject property and typed in the one she wanted. If a gray-haired grandmother is going to try that on me, I'll expect it from anyone now.
Vaccine #3: Suspect, verify or reject existing appraisals or appraisals ordered by anyone but yourself. If cost is a factor, existing appraisals can be reviewed by another appraiser for a cheaper cost than a new appraisal.
False Closing Documents
Some note buyers have put a lot of faith in closing documents and sale prices in the past. These can be totally irrelevant to today's values or even the value at the time of closing. Fictitious documents can even make it look like a note is in existence that never was real to begin with.
Vaccine #4: Rely only on current values and verify the legal documents and recording through title reports and title insurance. In addition, I usually pull my own “abstract of title” which shows me the history of the title not just the current status. The abstract has prevented several fraud attempts in the past. Look for the “coherence” of the documents. Both the abstract and closing documents can give you clues as to the legitimacy of the transaction and whether the documentation matches the story and details given to you by the note seller.
False Payment History
I have seen payment histories where the ink was still wet from being done up the night before (in the same pen and handwriting). One came to me in Braille one time. Even when they look legitimate, there is no way to verify a history of a note that was not collected professionally.
Vaccine #5: Do not rely heavily on payment histories. They can be faked easily and a good payor can turn bad or sell his property almost overnight. Rely on the property. It's the property that will ultimately pay you in the end.
These are just a few areas to check into and protect yourself against. There are many others related to the people such as, False Title Reports or Insurance, False cushions (false equity amounts that people try to create), Double closing (multiple property sales to inflate value), Down payment verification Representations (various other seller representations, statements and warranties).
In addition to these, there are the “Paper” and “Property” areas of risk and verification, that I will cover in future articles.