How $85 saved me $19,000 on a Notes Deal

[Wayne Snell]

I purchase non-performing 1st position notes. Like most notes investors I am used to seeing a lot of odd things during due diligence that can make or break a profitable deal. While my goal is to attempt to work with the borrower whenever possible to produce a win-win outcome (they stay in the home and begin repaying, and I earn a tidy profit for them doing so), in reality this only occurs for around 1/3rd of the deals I do. This is the story of a recent deal that looked like it was going to return a very strong profit for my joint venture partner and me in a relatively short timeframe. Boy was I wrong!

I found a non-performing 1st on a nice Florida condo in Boca Raton. The borrower was deceased, and the heirs elected not to remain current on the mortgage to the tune of 3+ years and counting. There were delinquent taxes and HOA fees outstanding. Simple stuff. After accepting the seller's counter-offer, I had a tentative agreement to purchase the note, satisfy the outstanding taxes, pay the back HOA fees (up to the 1% Florida Safe Harbor maximum) and foreclose on the property. All in, the estimated costs from acquisition of the note to foreclosure to either sold or rented would have been approximately $19,600. The rental comps for the complex and immediate area are strong, and the deal looked like a slam dunk.

Enter the $85.00. Since the seller had been slow to produce the electronic copies of the loan docs I decided to get in front of the curve and ordered a "full title" O&E report from a reputable vendor.

It turns out that full title O&E reports can miss a few things because it seems that not all liens need to be recorded. It wasn't the vendor's fault. Who knew?

As is typically the case, once I receive the electronic copies of the loan docs I send them off to a document review company where they look at the assignment chain to make sure all are recorded correctly, as well as review the title report AND the O&E. We were missing a few assignments, but again, nothing terrible. Here is where the fun started.

I called the county tax authorities and got the scoop on the delinquent taxes. Easy to pay them off. CHECK. Spoke with the HOA attorney to offer a settlement as they know if I foreclose I can simply wipe out their position as a subordinate lien. CHECK.

But wait. As we concluded the dance to get to a payoff number, the HOA attorney casually mentioned that "it really doesn't matter, because the land lease lien will wipe you (ME!) out anyway, so we both lose." WHOA! What?

I wasn't familiar with a land lease lien. And there couldn't be one on this particular property anyway, because the O&E report didn't show any such thing. Except there was. I called an attorney friend of mine who explained what the heck a land lease was in the first place. He told me that land lease liens are rare (mostly found in FL and CA) but are considered Super Liens when they do exist - and that I should run like heck away from this note investment. But I wasn't convinced yet. The deal just simply looked to good - with projected returns north of 30% annualized for my JV partner and me.

Next I called the document review company and asked about the impact of a land lease lien and why they didn't see it during their preliminary doc review. They didn't know the answers to those questions. So then I called the company that produced the original O&E report. As part of their fee they guarantee to rerun the report if I ever have a question about any information on there. In this case, I explained the issue, so they ran a "100 year" title search. And voila! There it was. Clear as day. To make this long story short, we decided not to pursue the asset, saving the $19,600 that we would have surely lost to the Super Lien foreclosure.

Moral of the story, due diligence is a critical part of note investing. O&Es are an important step in the review process, but they are not perfect! Be sure to call everyone involved and try to get the back story from each. If that attorney had not tossed out the Land Lease Lien comment, we would have had a very different outcome. While I wasn't pleased to have to make the call to my joint venture partner telling them we passed on the note, we both know this could have gone terribly wrong. Our money is safe and already deployed on another Note that will produce similar returns. What about you? Have you had any unusual issues like this one that you are willing to share with the group? We all benefit by hearing them as it can only help our due diligence efforts.

[Dion DePaoli]

Uncommon things can create scares. That said it is important to understand here that the leasehold is ONLY entitled to the rent due. There is a tone after reading the HOA attorney's comments that some power above the power to collect the rent due exists and it does not. Rent is a fixed fee only adjustable every 10 years if provided for in the contract.

Without looking at the full spectrum of documents it is difficult to understand the origin of the leasehold. Did the developer take leasehold or did the HOA take leasehold. Usually there needs to be a fee simple interest 'anchoring' the leasehold.

Upon any action brought forward under the leasehold it is fundamentally treated like a mortgage interest. However a right to cure does not expire until the judgement is entered. Further, a claim made on a leasehold interest would have to state the amounts due which the defendant can place in care of the court and even contest said amounts due. The court can award the full amount due under the leasehold if they see fit.

None of this is to suggest that the OP should have played with something he was unfamiliar with; more like a don't be too scared if you see this again. To 'foreclose' means termination of a parties right to redeem. There always has to be a redemption ability. Any holder of any interest which grants a right to foreclose is only ever entitled to the amounts due under said contract.

Typically the O&E reports that many folks are purchasing for a loan purchase are one owner back in history. If you are looking at cooperative properties that is probably not enough. Go further back in time.  100 years might be overkill in some settings.   Usually going back to where the developer took ownership interest is sufficient.  Again, the leasehold needs to be anchored by a fee simple estate.  In this case, that could have simply been one or two more owners in the search.  These leaseholds are not uncommon in lots of states and they were, as mentioned above, used to minimize the cost of building the property which in turn lowers the potential sale price of the units.

They are not free passes to foreclose or obtain possession of units.  Many states protect against such ideas.