Gerald(tx) shares the story of a fellow investor of his in TX. I thought it would be good for some of the more inexperienced investors who might be listening to some of the "no equity, no problem" GURUs to read it so I asked him if I could post the story here.

Read it and learn from it. Don't let this happen to you.

Sub2 is a great way to buy property but you can't polish a turd.


"I recently got a call from a woman quite distressed, seeking my advice. She had lost $71k in a little over a year from her Sub2 investments. Her savings were gone, her credit cards maxxed out, now she faced possible lawsuits. She made a lot of mistakes as a newbie. I thought I would relate her story here, perhaps it will help some newbie avoid the same. As you read, you can spot her mistakes.

First, she got a realtor friend to find the properties for a bird dog fee of $1k each. He quickly found five homes, just what her course had told her -- one or two year olds, it didn't matter if they had no equity -- appreciation would make her rich.. All of them had mortgage balances of around $135k. So she got into the homes simply by making up a couple of back payments on each, plus a little paint and spruce up.

One of the things she didn't realize was that these homes were originally $125k, but when sales got slow the builder did a "one dollar total move-in" marketing by rolling the down payment and closing costs into the loan. So she was really into these $125k houses at about $140k.

Next thing was to offer them for sale, no qualifying, owner financed. Her guru had said to add 10% per year for appreciation, and get a minimum of 10% down. Plus, create a new note jacking the interest rate up 2 points for a good cash flow. So she did just as her guru said, advertising them at $170k, with $17k down, and high payments.

Three months passed, along with her making 15 more house payments, not a single sale. Then reality set in, the guru's "magic formula" didn't fit all areas. Here, most owner financed homes got around $5 or 6k down. And payments had to be reduced to the current market. She filled three of the houses and by the fifth month was taking anybody who could fog a glass, who had anything down, vacancies were killing her. Even though she kept $170k on the contract, she didn't understand that T/Bs who agree to pay $45k above market will never follow through and refinance when the contract is due.

The next thing she didn't realize was initial taxes are based on vacant lot assessment, and to her surprise she was notified that all of the houses would have escrow shortages and the payments would be going up about $400 per house, per month.

In a further calamity, several "one dollar move-in" neighbors defaulted and went into foreclosure. Since appraisals are based largely on recent sales, foreclosure auction prices watered down the appraisals to around $118k. Yes, properties can depreciate as well as appreciate.

To top it all off, a couple of her T/Bs got behind in their payments, moved out and trashed the places. So she dug further into her funds for refurbishment.

When she called me, one of her five houses was performing, two were vacant, and two were ready for eviction.

She had talked to one of her former sellers and asked if he could take the house back. The seller refused, got irate and threatened to sue if she allowed the property to go into foreclosure. He had sold it to her for debt relief so he could preseve his credit. If she ruined his credit, he would sue to take her personal residence.

I wish I could say I helped her, but I'm afraid I didn't. She was wanting to know if she could assign the homes to another unsuspecting newbie. There are legal problems here also. Or giving the deeds back in lieu of foreclosure, even though her name wasn't on the note. She was asking if bankruptcy was the best to protect her homestead or if she could create some kind of trust to save her assets.. I sympathized with her but she has some serious legal issues with which I didn't want to be playing lawyer.

It's sad to see situations like this. Here is a nice lady who just wanted to make a little money in real estate, now she's in debt, lost her savings and could lose her home.Many gurus fill their students full of hype to peddle their courses, but it's not all the guru's fault. Newbies get stars in their eyes and become completely oblivious to the risk involved. The risk is real. I've been investing for over 20 years and I still lose on a property occasionally. Any other old timer will tell you the same thing. I have had many profitable Sub2s and made good money at it, but I admonish every newbie to tread lightly with caution -- particularly as we enter into the coming period of rising interest rates."

Having been a landlord since the early part of 1994, I feel fairly safe in stating I've tried almost every imaginable way of collecting monthly payments from my residents. I want to run through some of these methods and let you in on the pros and cons of each technique. I'll wrap it up by telling you what I do now.

Personal Collections

Scheduling appointments to pick up payments was never even a consideration for me as a standard way of doing business. I'm too lazy and I consider it the resident's responsibility to pay me if they want to stay. The advantage is that you know right away who's paid and who hasn't. You still don't know if the check will clear with good funds, assuming you weren't paid in cash or certified funds.

Of course, I've met with residents to pick up payments on special occasions when the resident was late or trying to avoid late fees. Again, this is a waste of time in my opinion.

I now have a designated place for the residents to drop off payments if they want to go this route. Also, for chronic late payers, they lose the privilege of paying any other way than by certified funds at the drop box. Once they've paid consistently and timely for six months, I'll consider reverting back to the standard pay system I'll discuss later.

If you do decide to meet your residents to collect, I highly recommend NOT meeting at your personal residence. Do not allow any of your residents to know where you live. In fact, my opinion is that you should have an unlisted  telephone number for your home line and that you should spend as much time as necessary removing personal information from the various internet directories. Sorry for the tangent here, but I thought it important enough to include.

I don't recommend this method as it requires too much effort on your part.

The Check's in the Mail

This is probably the way everyone starts out. The payment doesn't arrive and the resident claims it's in the mail. If it arrives, is it even good? Who knows? The advantages to this method are that it's very common, and if you have a great tenant, it can be a low hassle way to collect payments.

The disadvantages include reliance on the resident's memory to write the check, correctly address the envelope, place the correct postage on it , and actually drop the payment in the mail. Additionally, you then rely on the postal service to deliver the payment to the correct address and in a timely manner.

I've even gone as far as providing payment coupons and self-addressed stamped envelopes to residents to remove some of the risk associated with this methodology. I didn't find this added effort to produce any noticeable difference in the results.

I don't recommend this method as it requires too much Involvement from your resident.

Resident Makes the Deposit

I realize many of you will completely balk at this idea, but I've tried it for years now with some success. Prior to having a drop box location, I would give my late payers a bank account number to which they could deposit the monthly payment directly.

Naturally, I graduated from that step to providing deposit slips that were pre-printed so the account name and the account number wouldn't be inaccurate. In this case, this added effort did reduce the monthly "I don't have such and such information" telephone calls from the residents. I was never that concerned about a resident attempting to make a withdrawal from my account, although I'm sure that's a possibility. To decrease this risk, you could have a separate bank account for deposits and sweep the funds into another account periodically.

Another consideration here is that potentially you could run into a failed eviction for accepting partial payments. Whether or not a judge would consider a tenant making a small deposit in a last ditch effort to avoid eviction "constructive receipt", I'm not able to answer. So far, (knock on wood), none of the folks I've evicted have tried this angle.

However, what will invariably happen is that residents WILL make partial payments. The truck broke down, the child custody legal fees, etc. get prioritized over shelter and what few remaining funds there are end up in your account. Then you're left with the fun job of trying to determine who paid what.

Advantages to this method are that you don't have to make a trip to the bank and if you have online banking, you know within a day or so if the deposits are there. Again, you don't know whether or not they paid in pennies or stolen checks from their neighbor, but you at least see the deposit made.

I don't recommend this method as a standard way of collecting, but perhaps consider it for the good payer who's just had a bad month.

Print the Checks for Them

(Thanks to Earl B. for the following tip)

I forget when it was, but probably sometime around eighteen months ago, one of my friendly competitors suggested I try this service. One of his friends was using it with success so I signed up for it. It's inexpensive and allowed me to just sit down and print all the monthly payments at one time. I signed all new residents up on it and bribed some of my existing residents to join.

The service is presented to the residents as an auto draft service and they sign off on a one-page form that authorizes you to debit their account. The program itself is a Windows-based software application that allows you to print these "Demand Drafts".

The advantage is that the payments can be set up as a recurring monthly payment and you can print them whenever you want. So, rather than waiting for the mail to arrive, you just sit down at your PC and hit print. The checks roll off your standardized printer. In other words, you don't need any special equipment. On the first of each month (or whenever) you just head on over to the bank.

Again, you don't know if the resident has good funds or not, but at least you're not waiting to make your deposit. One of the disadvantages is that you will have to purchase check stock, but I believe I received 300 checks with my initial purchase.

Another advantage to using this software is that you could set up your own bills on this so that each month you just print out your recurring bills or a set of blank checks with your pre-printed information.

You can find out more about this software by clicking on the url below. Please ignore the cheesy web site and examine the features and benefits for yourself.

http://www.TexasRealEstateClub.com/checkman.html

I no longer use this method, but can recommend it as It worked well for me.

Direct Deposit

For the last year I've been using a new service I found. I searched high and low for a reliable, quality direct deposit service that wasn't designed for the huge apartment complexes. Everything I stumbled upon had a fee structure that priced it way out of my league.

Again, as before with the CheckMan application, I signed all my new residents up on it (company policy, don't you know?) and bribed some of my existing residents to join as well. I think it's fantastic.

Residents receive an email notifying them of the coming draft and it all runs through the banks Automated Clearing House systems (ACH), so there's absolutely nothing that I have to do.

The resident's account gets debited automatically on the designated day and I receive an email the next day that shows me which accounts were drafted successfully, and which failed, if any. Three days after that, the funds are automatically deposited into my account.

The residents know it's coming and since it's automatic like other bank drafts, it requires no effort on their part. It also requires no effort on my part. It's the simplest solution that I've found and very affordable to boot. Rather than go into all the features and benefits here, I'll just give you a link so you can read about it at your own convenience.

http://www.clearnow.com/public/ClearNowEnrollmentGRQ1.pdf

I also got them to agree to offer a trial period. If you sign up through the link above, they will give you two full months to try the service at absolutely no cost. I know that if you give them a try, you'll be hooked.

Sincerely,

Tim Randle