Don't mess with building inspectors

[Jon Holdman]

In another thread I mentioned one of my hard money loans was going to default. It did, and my business partner and I have now taken back the house deed-in-lieu.

The place has some cosmetic issues. Its total white inside, the yard is a mess and the decks need some attention. But the big issue is the lack of permits. The borrower did get permits for a roof and siding, but nothing else. He did pretty complete remodels in the kitchen and baths and put in new windows. Needless to say the inspector noticed the new windows. Then he started looking around and noticed the remodel. We met with the inspectors (main, electrical, plumbing and mechanical) last week and got some input on what they wanted done. The plumbing inspector was insistent on opening up the walls and floors so he could have a look. He said he looked at the property, and no permits had every been pulled since it was built in 1940. So, everything is now our problem.

In particular, he pointed out this in the floor of the laundry room:

Its a little tough to see in that picture, but a cut was clearly made in the concrete for that drain pipe. Now, who knows how long ago this was done. It was not done by our borrower. That pipe leads under some nice new tile into the bathroom:

Well, it was nice new tile. This is what it looks like today:

Sigh!

Still wanting for the full bid from the GC on what its going to take to fix this mess.

[Jon Holdman]

There are several.

For one, get permits. I know people tend to take short cuts and skip permits and inspections. If you get away with it, that may save you some money, and especially save some time. But if you get caught, it can cause you a lot of extra work.

If you going to lend, keep an eye on the deal. We work through a broker, and he holds the repair escrow and does the inspections. Too much of the escrow was released too soon. Had we been watching more closely, we could have seen the work was unsatisfactory several months ago and done something at that time to try to fix the situation.

Be sure about valuations. Before we started in this deal we had an appraisal. That appraisal gave a $213K value, after the fixup was completed. It was by a licensed appraiser, and the comps looked solid. This property is one a somewhat busy street. All but one of the comps were on the same busy street, and the remaining one was on an even busier street. The borrower had this under contract at $163K and his appraisal came in at $166K. That's a HUGE difference. Now, some of the cosmetic issues dragged down the value, and I suspect these issues with the city also caused him to look hard at the house. And one of his comps looks like it was a probate deal rather than a fixed up house. But that just kills the whole deal. I am hopeful that once we resolve the permit issues and really finish the fixup that we can come in a fair bit higher than the latest appraisal. But there's no evidence now that we'll get up to the $213 original appraisal. I do think there has continued to be some decline in the prices in our area, but I don't believe its been anything nearly this dramatic.

The busy street is a more complex issue than it might seem. Yes, it hurts the value. We knew that going in, and considered that in the selection of comps. The limitation of chosing comps on that street is the issue. Rather than having several dozen recent sales, there are just a few. So, those specific sales being low vs. the ones from nine months ago means you're really stuck with a significantly lower value. A house off this busy street would have a much larger selection of comps. So even if the appraiser tends to the low end, he's not going to be stuck.

This was a thin deal from the start. Purchase plus rehab was 75%. We only loan 70%, but the borrower had some of his own money into the deal. He did make the payments for eight months. His loss will be greater than ours. But there came a point when he just couldn't stay in the deal. I know folks push back on the 70% guideline, but there really is a reason for that.