Q: Several years ago, my in-laws approached my then-husband and I with a real estate business proposal. (They owned a mortgage company.) We could buy the home of one of their clients, who was struggling financially, and let the owner lease it back from us for a few years until she was back on her feet and would buy it back from us under a lease-option agreement. We would get the tax write-offs and $10,000 from the sale, the owner/tenant would get her bills paid off from the sale, and we’d basically have to do virtually nothing. We agreed to do the deal, but we did it in my name only.
Now, I’m divorced, and the property has depreciated drastically — we paid $500,000 for it, and it’s now worth only about $150,000. The former owner is still there, but has no down payment saved up, which is now required to get a loan. Also, there’s no way she can get a mortgage for anywhere near what it would take to pay my mortgage on the place off, and the payment is adjusting beyond her or my ability to keep up with it. I’ve had no luck seeking a loan modification, so now my only options are to walk away from it or help her scrounge up the down-payment money and do a short sale to her — either of which will cause major damage to my credit report. What should I have done differently?
A: Your error was the error of many of your countrymen (and women) during that era of easy mortgage lending — we bought into the notion that real estate was an asset that could and even should be used for quick and easy gains, even in the absence of equity or other strategy for achieving legitimate upside on the investment.
There are thousands of flippers and other investors more skilled at timing the market and evaluating an investment’s risks than you who, I’m sure, would argue that there’s nothing inherently wrong with a short-term investment model. And I agree — there’s nothing inherently wrong with short-term real estate investments, in theory, or even in fact, assuming the fundamentals are sound.
But one of the problems with real estate investing, in an era where mortgage money is cheap and easy to get, is that something about the scale and speed of the potential returns emboldens teachers, plumbers and aerobics instructors to jump on into the fray, often with no more than a Learning Annex class and a copy of "Rich Dad, Poor Dad" as education.
(Not to disparage either — but they are intended to be a starting point for an investor’s education rather than the sum total of that education.) Nine times out of 10, this means that the investor is unqualified to determine whether the fundamentals of a short-term real estate investment are sound, which is how you ended up in this situation.
Normally, in real estate investing, as with anything in life, the rewards and risks are proportionate. However, in your situation, the rewards for you were disproportionately small (in my humble opinion) compared with the very large risks. To be frank, it makes me wonder whether the potential rewards were much larger for the middle man (or woman) mortgage facilitator who brokered this deal.
First off, the tax advantages of owning an investment property are nowhere near as compelling as those realized on your primary residence. Additionally, had you a better real estate investment and/or financial education, you might have better understood the potential risks that the owner would not be able to perform (given her financial struggles at the time of the deal).
You might also have better appreciated the consequences of a decline in the property’s value — namely, that the former owner would neither want nor be able to repurchase the home at the price you paid — you might have decided that $10,000 was not worth the years of then-predictable and -avoidable credit consequences, which are now, unfortunately, inescapable.
With all that said, you stand to realize some benefits from this experience. As dramatic and traumatic as the last couple of years have been for our country, from a housing market perspective, the silver lining just may be that we move forward with a revolutionized perspective and mindset on the importance of informed and deliberate real estate, mortgage and personal finance decision-making.
Once you have a resolution on this matter, I predict that you will approach these sorts of decisions with an eye for risk-minimization, an emphasis on ensuring the fundamentals of a good investment are present, and an inclination to avoid getting in over your head. Oh — and you might select your advisers more carefully, too. My very best wishes go out to you.
Tara-Nicholle Nelson is author of "The Savvy Woman’s Homebuying Handbook" and "Trillion Dollar Women: Use Your Power to Make Buying and Remodeling Decisions." Ask her a real estate question online or visit her Web site, www.rethinkrealestate.com.
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