Real Estate Financing Tips

How To Finance A Fix-Up

by Marvin Levin

There were still plenty of foreclosures in the early 90s, and Charlie haunted foreclosure sales.  I am not sure whether or not it was a good use of his time but I can tell you that he struck it rich on one particular foreclosure.

Charlie got the money to attend the foreclosure sale from his sister, and then wanted to repay her by getting an equity partner.  On paper, it seemed easy to do because Charlie’s purchase price looked to be 60% and 70% of the property value. 

A retired doctor put up the equity money (which was immediately repaid to Charlie’s sister), and the doctor and Charlie formed a partnership.  The agreement was that the doctor would be a passive investor, and that Charlie would do the work needed to evict a tenant, rehab the building, refinance the building with permanent financing, repay the investor’s money to the extent possible, put the building on the market for sale, and to enjoy the riches of real estate. 

Well, you can probably hear from the tone of this message that it didn’t work as well as that.  It turned out that Charlie loved to attend foreclosure sales, but hated to manage buildings.  The tenants did not get evicted for many months.  The rehab stalled, and when it finally got underway there was a major cost overrun.  Charlie actually hired some subcontractors who took the money and did not pay their labor.  Liens were flying like machine gun bullets.

There wasn’t much question that Charlie had the intellectual ability to perform, but it became painfully clear that he simply either couldn’t or wouldn’t do the work required.

A BETTER WAY

I am sure it will occur to the reader that there are many better approaches than the one taken by the investor.  Consider the following plan as one alternative:

1. Investor takes title in his sole name (i.e., forget the partnership idea for now).
   
   
2. Investor hires Charlie as an employee, or a consultant, to do a specific list of tasks in sequence.  For example, the list might specify tenant eviction on or before a certain date, rehab completed according to Schedule A attached on or before a certain date, refinancing completed on or before a certain date, property listed for sale on or before a certain date, etc.  In addition, this employment agreement would give to the investor the right to approve and/or veto some or all of the decisions made by Charlie.  (Note that this would require Charlie to trust the investor, and also note that in the transaction described above it was the investor who had to trust Charlie.)
   
   
3. Then, if Charlie walks off and ignores the project (as he did in our example), the employment agreement is cancelled and the investor, now free of a partner, will do his best to find someone to do the work and hopefully make a profit.  The investor may still have problems, but many fewer than the problems arising from a failed partnership.

If you come across a rehab project, perhaps we can help.  Please contact me.