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10 Years Delinquent, Story 1: Condo Homerun!

One of my favorite things to do when talking to someone about what I do for a living is casually dropping the fact that a borrower hasn’t made a payment on their mortgage for ten years. A few months ago, I did this with a car salesman (really nice guy) who sold me my last car. He stopped to look at me, his jaw dropped, and he asked slowly, “How does someone go ten years without making a payment.” This leads to a fun (for me) conversation explaining how these things work.

Unfortunately, the 10 year plus delinquent loan is not a unique thing like a unicorn. I’m seeing more and more of them in our Fund portfolios and each has its own story: cunning (or clueless) borrowers that take advantage of any and every opportunity, complicated title scenarios that are difficult for bureaucratic big banks and servicers to handle, sometimes the loans are kind of forgotten and no one cares to make decisions on what happens to them.

“10 Years Delinquent”

This is the first in a series of stories devoted to the severely delinquent loans that take years to resolve, how and why the process took so long, and how we ultimately took these NPNs to their conclusions. I’m going to include a special section at the beginning to give readers a quick picture of why the note was delinquent for so long. For this loan, it looks like this:

Next Payment Due Date: 06/17/2010 Date of Foreclosure: 05/21/2019 Total Delinquency: 8 years, 340 days Prior Loan Modifications: 0 Bankruptcies (last 10 years): 0 Property Transfers: 5 Reasons for Delay:

  • Borrower’s Actions: 0%

  • Complicated Title Issues: 50%

  • Inefficient Big Bank and Attorney Firms: 50%

The First Look

I loved this note from the very beginning. The property backing the note was a condo in Highland, California, about an hour’s drive from our office. I knew the area like the back of my hand because I purchased about 25 condos in this area at trustee sales from 2011 to 2013. This particular association was located about a quarter of a mile away from four of my rental condos in the same city.

We first saw this loan on a tape at the beginning of 2018. It was a HELOC (“Home Equity Line of Credit”) originated by one of the 5 big banks in 2005. The servicing comments indicated that a Quiet Title Action was going to be needed because two old loans were never reconveyed during the refinancing. There was no title policy because this big bank’s practice at the time on HELOCs was to do a less expensive title search but not get a full policy.

Another loose lending practice from the period before the mortgage meltdown that’s resulting in actual problems for a future note holder.

We passed on the note at the time. The QTA hadn’t been initiated yet and we thought it was too big of a risk for the small Fund we had at the time.

The Second Look

Fast forward to January, 2019, and we saw that this same loan was still for sale. I knew that condos in the area were going up in value because I monitor the values of the rentals I have every quarter. Funny, the seller’s valuation looked really low compared to what I knew it should be worth.

The servicing comments indicated that the QTA had been initiated. I revisited the documents we had from before. In the origination docs, there was a payoff demand and other evidence that an older loan was being paid off in association with a refinance.

Wraparound Loan

One unreleased loan was originated in 1983 by a company that was no longer in business. The second unreleased loan was originated in 1997 by a previous owner that “wrapped” the 1983 loan. In a “wraparound” loan, the seller creates a new loan in which the buyer makes the loan payment directly to him. The “wrapped” loan is not paid off and remains on title and is an active loan.

When the buyer makes a loan payment, the seller pays the old or “wrapped” loan directly and keeps the remainder for himself. Sellers do this to help buyers that can’t or don’t want to get traditional financing. 1997 was a hard year for the real estate market and for condos especially so this situation is understandable and not too unusual. The “wrapped” loan’s lien remains in senior position and the new loan is junior to it.

Investment Property at the Peak of the Last Market

The condo was a rental and not owner-occupied. The borrowers had refinanced for $169,000 at the peak of the last bubble. When real estate markets crash, condos take a huge hit in price because bank financing will disappear for units at the lowest price points. In 2010, this condo would have been worth about $40,000.

HOA Foreclosures

Looking further into the chain of title, I could see that the HOA foreclosed on the property in 2010. If an owner doesn’t pay their HOA dues and the amount owed is more than $1000, the HOA can place a lien against the property and foreclose. Typically, they’ll wait until the amount owed is several thousand dollars before doing so. Once the HOA forecloses, they become the new owners of the property and can rent it out or sell it to recover the unpaid HOA dues.

This made me believe that the borrowers decided to walk away from their underwater investment property. They weren’t making their mortgage payments or their HOA payments and had allowed the HOA to foreclose. This meant that the borrowers were no longer in the picture and wouldn’t add the additional complications that an owner-occupied property would, another big reason why we would want to buy this note.

Five Property Transfers; What a Mess!

Further inspection of the chain of title revealed that the HOA deeded the property to an investor. Over the course of the next 8 years, the property switched owners, three more times. The HOA foreclosed on the investor for non-payment of dues. A third party bidder purchased the property at auction for the amount of the back HOA dues, about $7000.. The poor HOA had to foreclose on that third party bidder a few years later but the same third party bidder purchased the property at auction again. Finally, the third party bidder sold the property to another investor in late 2018.

What does all this mean? Unable to continue making their payments, the original borrowers lost the property to the HOA, which sold it to an investor in the hope of collecting unpaid dues. Because there was a large loan still attached to the property, the investor’s goal was to rent out the property for as long as he could (or live there himself) without making the mortgage payments.

Eventually, the bank would foreclose and take the property back so the investor had to make as much money as he could until that happened. The problem was that the bank wouldn’t foreclose any time soon because of the title issues but nobody else besides the bank would know that. Nine years would pass before it could be straightened out.

The attorney firm seemed confident that they would be able to clear title. That was good enough. Now, we needed to sort out the issue on value.

Why the Low Property Value?

The seller’s BPO (“Broker Price Opinion”) came in at about $85k but I knew from experience that the condo should be worth about $130k. I looked at their BPO and saw what the issue was. The agent was using the comps from the condo association where I had my four rental condos.

Although the condos were a quarter mile apart the difference in quality is unreal. My condo complex, for some reason, was an island of criminal activity. In physical make-up, it reminded me of the housing projects in L.A. that I patrolled 20 years ago. It was really bad, robberies, shootings, a murder every now and then. One of our rental units had even been shot at once.

BPO was well done but was still wrong

There were so few sales in the target HOA that the agent that prepared the BPO was using comps from the crime ridden HOA, which is a reasonable practice. Unless you had personal knowledge of the area, you would never know how very different they actually were. Instead of showing the $130k value, which I knew to be correct, the seller’s BPO was reflecting the lower $85k, which was the proper value for the crime ridden complex.

I told Sean that we had to get this one, he did his negotiating magic, and we got a great price for it. Our own BPO came back at $80k. I challenged it but their value only went up to $85k. I looked at the revised BPO and it was well done. Here was a situation where everything was showing the value to be $85k but I knew that it was really $130k. Sean believed that I knew what I was talking about and we pulled the trigger.

Clearing Title with a Big Attorney Firm

We don’t like to wait. As soon as we closed the transaction we contacted the attorney firm handling the QTA to get the ball rolling. This was a large, well-known attorney firm. I knew from the beginning that we might have problems when they don’t list the attorney’s phone number and require you to go through a “gatekeeper.” We got the feeling that our case was just another number to them, another way to grind out fees, without regard to efficacy, efficiency , or any sense of urgency. When you’re so big and you have big clients and a huge caseload that won’t go away any time soon, why would you care too much about a single, impatient investor who calls all the time wanting to know the status?

It turns out that the QTA hadn’t even been filed yet. Strange, we knew that the paperwork had been completed for months. They indicated that they had never gotten approval from the previous noteholder for a certain amount of billable hours. Well, we gave approval so let’s get going.

The attorney firm continued to disappoint us with slow service, slow responses, late filings, and generally doing a terrible job over the next month. We transferred the file to an attorney with a small operation who we felt would get the job done quickly.

Clearing Title with a Responsive, Competent Attorney

Our new attorney quickly discovered that one of the liens had recently been reconveyed in late 2018 by the successor bank for the 1983 loan. We wondered why it didn’t show up in our title report from when we bought the loan or why the previous law firm didn’t catch it. We continued to be dismayed by the quality of the work of the large attorney firm, even after we had fired them.

Continue with Foreclosure & Clean Up Title Along the Way – Genius!

Our attorney advised us to go ahead with the foreclosure while we sorted out the title issues. Typically, the big banks are afraid of making mistakes and won’t allow a loan to go to foreclosure sale until all of the title issues are taken care of first. Proceeding with the trustee sale while proceeding with a QTA that we knew we were going to win would save us a lot of time and made a lot of sense. We knew that the condo was most likely tenant occupied, which meant that we would have to give them a 90 day notice to vacate, a requirement in California following any foreclosures. We could have the timelines run concurrently. No one bid on the property at the trustee sale so it reverted to as REO.

Final Title Clearance

Our attorney tracked down the private party that initiated the second lien. She was served for the QTA and her attorney communicated with ours. After some back and forth, she agreed to execute the required documents for a modest fee, which was generous considering that the big bank had already paid her back in full. Their mistake allowed her to make a little bit more money at our expense.

Uncooperative Occupant

We almost always offer cash for keys to occupants of foreclosed properties. Much better to have a cooperative occupant with plans to move than to have the uncertainty and risk of someone who could damage the property and draw things out in eviction court. We attempted to contact the occupant but he was avoiding us. After a couple of weeks of trying to get a hold of the occupant, we filed the eviction.

That got his attention! Actually, it got the mom’s attention. I received a call from the occupant’s mom, after our attorney posted the eviction notice on the door of the condo since they couldn’t serve him personally. The mom was a real estate investor and negotiated cash for keys on his behalf for a very modest amount. He bought the condo anticipating, like the others before him, that it would be a while before the bank foreclosed. Unfortunately for him, the big bank sold to us and we weren’t going to wait around for things to resolve themselves on their own!

Good to Go

Finally! We had the property and we had clear title. Time to do a rehab and put this on the market! When our real estate agent did the first physical inspections of the interior of the condo she discovered that it was a bigger unit than we originally thought. The county assessor had the wrong information! Instead of having a 2 bedroom, 1 bath, 801 square foot condo worth about $135k by this time, we had a 2 bedoom plus a loft, 2 bath, 1200 square foot condo worth about $170k! I’ll take another $35k in bonus money any day. To confirm our original analysis, though, selling it for $130k would still have been a great deal. This windfall was a great bonus!

We did a moderate, cosmetic rehab which made the condo sparkle, put it on the market, and had several offers come in over the next couple of weeks. We sold it for over list price and made a killing thanks to the assessor’s mistake. Another non-performing note transformed into a beautiful new home for a new first time home buyer!

Things I learned:

  • Informational advantage regarding the value of the collateral property can get you a great deal.

  • Don’t be afraid of thorny, complicated issues. Do the research to determine if the title problems are curative or not.

  • Don’t allow a large attorney firm to treat you like a number and act without urgency. Be quick to transfer a file to an attorney firm where time is of the essence, the attorneys are accessible, and do a great job.

  • In general, it’s better to offer the other person cash in exchange for their cooperation. We offered the prior lien holder cash to resolve the title issue quickly as opposed to taking a longer time and incurring additional legal expenses by going through court. We offered the occupant cash for keys instead of going to court for an eviction. In both cases, we had a high probability of success but you are always taking a chance that things won’t go your way if you get the wrong judge.

  • When dealing with NPNs, the “Obstacles Are the Way.” It’s part of the business, sometimes they seem insurmountable, but you’ve got to stick with it to the end.

Final Numbers:

Purchase Price: $60,090 Total Cost Basis: $98,011 Net Sales Price: $164,707 Net Profit: $66,696 Days Held: 269 Return on Investment (ROI): 68.0% Annualized ROI: 92.3%

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