Never (Ever!) Offer a Distressed Seller This...

The flyer I left on Jack’s door that day explained I was a real estate investor. I could buy his house, pay cash and close quickly. Unimaginative, I know, but effective.

Jack was in foreclosure and needed help. Quickly. The auction date was less than a week away. I knew this because, desperate and out of options, he called after finding my bright yellow letter.

I was a little nervous to meet with him. After all, Jack had over $80,000 in equity in his home. With careful negotiation I could score myself a home run deal.

As we sat in his kitchen Jack described his financial situation. He was disabled from a previous job and living off the insurance. Some unexpected expenses came up and he couldn’t pay his mortgage. He got behind and couldn’t catch up. Sad, but not uncommon. I’d heard many stories like his before. I listened carefully and told him I understood.

Then Jack bottom-lined the deal – he would only sell to me if I allowed him to stay in the house and give him the opportunity to buy it back in a year or two.

Now I was told early in my real estate investment career to never, ever allow a distressed seller to stay in their home. It was explained to me that the day you bail the homeowner out of a bad situation you’re a white knight. But the moment things go sideways you’re the devil.

Still, this was an amazing deal. I thought, what could go wrong? Jack’s troubled financial past was behind him. All he needed was a second chance.

What Went Wrong

My company bought Jack’s house for $200,000 and he received $15,000 in cash at closing. He also signed a 12-month lease agreement and separate option to purchase for $230,000. His monthly rent payment was actually $150 less than his mortgage payment. In a year Jack would get his house back and I’d make $30,000 in profit. Of course, if he couldn’t exercise his option then I’d get to keep the house and all the equity.

Jack’s first lease payment, due February 1^st, didn’t show up in the mail until March 4^th. It was an out of state check that bounced. I never received another check from him again. Luckily for me, the eviction process in Arizona is swift and efficient. I had him evicted in 30 days. I wholesaled the house to another investor two weeks after that and pocketed $25,000.

About 11 months later a process server showed up at my door. Jack had retained a lawyer and was suing me for mortgage fraud. Worst of all, they named my wife and I personally in the suit. Never mind that there wasn’t any mortgage involved in the transaction (we used a standard lease/option agreement) – in this country anybody can sue anyone at anytime for any reason.

I retained one of the top real estate attorneys in Phoenix. Responses were drafted, depositions recorded, and motions filed. In all I spent over $40,000 defending our company from Jack and his frivolous lawsuit.

Finally, after more than 14 months of bickering Jack and I settled out of court – for $17,000.

Just Say NO to the Distressed Seller

That was 2006. The day I scratched that check for $17,000 I vowed never to allow another distressed seller to stay in their home again. It’s either sell to me and move out or no deal.

I highly recommend you use the same approach.

Here’s why – regardless of how you structure the deal (lease/purchase, lease/option, owner carry back, contract for deed, etc.) the homeowner will never be able to emotionally detach themself from the home. It will always be “their home”, no matter what name is on title. So when the time comes for you to evict or foreclose because of non-payment or inability to obtain new financing that former-homeowner-turned-tenant will fight you with every ounce of strength they have to stay because it’s really “their home”, not yours. The sweet, appreciative homeowner who once thought you were so wonderful and understanding will lawyer up and say you were a greedy, vicious liar all along.

The Short Sale White Knight

The game has changed a lot since I did that lease-option deal in 2006. I’m hearing about investors now that offer to purchase houses from underwater homeowners and then resell them back after the deal closes. There is a firm here in Phoenix offering to do this and has received acclaim from local news outlets for “helping out” distressed home sellers.

Take my word for it – it’s a flawed business model, and not just for the reasons I mentioned earlier. Most banks now forbid a short sale homebuyer from having a pre-arranged agreement with the home seller. Some of these banks even require the purchaser sign an affidavit stating no such agreements exist.

While allowing a distressed seller to remain in their home may seem like a noble endevaour, it’s really just prolonging the inevitable. There’s little chance they’ll ever be in a position to repurchase the home from you.

It’s much more probable they’ll come after you if they can’t. And I have 17,000 reasons why you don’t want that to happen.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.