Rats Plus Termites Equals Gold!

I get a weekly newsletter from my friends at the Broward Real Estate Investors Association and in this week’s installment, Dave Dinkel wrote a real doozy of an article on how to get a deal done when everyone else runs cowardly away. Check it out.
A mentoring student called and asked about a property that he found.  He is dealing with the homeowner direct and he requests an inspection.  There are tons of deals out there that are not REOs and this is one of them.  The student notices rat droppings and holes where the rats have infested certain areas of the property.  The property is vacant so the damage and rat presence is now very noticeable.

Fact – a rat’s front teeth grow at a rate of about 30 inches (30″) a year so they have grind off their teeth so they fit in their lower jaw.  That’s the reason you will see teeth marks on wood and abrasive surfaces in properties.  For those of you who love squirrels (rats with bushy tails), they have the same problem and I can personally attest to the power and length of these front teeth as I got bit by a squirrel on a hunting trip.  The litter sucker bit entirely through my thumb and thumb nail – that hurt!  Oh yeah, because I am so gracious and forgiving, I invited him over for dinner that night (he tasted just like chicken).

Overall the property is in good shape and the estimated rehab is about $30,000 to $40,000 to make the property into a show case.  Comps and open listings in the area are in the mid $200,000 range to low $300,000 range.  The seller was asking $190,000 and after back-and-forth negotiations, the seller accepts the student’s offer of $125,000.

If you aren’t thinking the following, you should be -  “How did the student get such a low price?”  The answer is very simple – by not offering to high a price to start and knowing the most he would pay before he started the negotiation process.  The killer for most newbie investors is that they fall in love with a property or its “potential”.  The only potential is what it can realistically be sold for in a buyer’s market, in a reasonable time, and not at the lowest price in the neighborhood. 

So the seller agrees and signs the contract and the student calls a company that he was referred to by someone, other than us, to do an inspection.  The student calls us in a panic and says the professional home inspector believes the property should be demolished!  The other surprise was that the property is frame construction and not CBS as was expected even though it was built in the late 1980′s.  According to the inspector, the termite destruction was so extensive the property should have been torn down and re-built with CBS construction.  The student is panicked and obviously very concerned and calls us to see what to do.

Having been involved in termite and rat infested properties, I asked that he go through the whole inspection process report with me.  Frankly, I was shocked that the damage could have been so extensive.  I asked a series of questions about the abundance of droppings and wood damage and became more and more skeptical about the inspection report.  At the time I was leaving the office for an appointment and Bill was also.  Jan stepped up to the plate and volunteered to go and see the property immediately.

Jan called me on my cell to say that she had climbed up and looked into the attic and the termite damage to the rafters and beams was not that extensive and the internal wall damage was minimal and could be easily repaired – if it was even necessary.  Now this is food for thought as suddenly a tear-down becomes a remodel with some extra work!  She also saw fresh rat droppings and seemingly fresh termite “pepper-ploppers”.

So I asked myself, why in the world would a professional inspector give a report that the property was “Probably better demolished and rebuilt as CBS”?  Let’s first assume that he believes this to be true, if so, he would have based it on the same structure that Jan saw and while Jan is not a licensed property inspector, I suspect she has seen more properties than the professional inspector.  While I don’t like to believe it could happen, what if the inspector is a closet investor who wants to get the property himself because he realizes the potential $100,000 to $150,000 profit?  That is a lot of home inspections in any market.

To get a second and more competent opinion that I really trusted, I called the property inspector we use and asked him to do another inspection.  He is the guy at the BREIA meetings that has the infra-red gun to detect termites and water damage that is invisible to the naked eye.   I would like to mention his name but I can guarantee that some people reading this letter will construe him as the first inspector – whose name I cannot mention.

So he inspects the property and gives us the result that there is termite damage and that the repairs could be $40,000 and the rat problem needs to be fixed ASAP.  No mention of tearing down the property and starting all over again which would have cost $125,000+ for the size of the house.  This is a big difference from the first opinion and the second opinion that agrees with our thinking – the real difference is making a deal work or walking away because of the huge replacement cost.

With the first report in hand (tear-down), the student goes back to the seller and attempts to renegotiate with the seller for a lower price.  He is successful at getting a slightly lower price so the “second opinion” inspection report both saved the student a lot of money and kept him from walking away from a great deal.  I will always question the real motive of the first inspector as I am assuming he was competent to make the assessment of damages.  Remember he was referred from a friend of the student and not from BREIA!

On another note -

I have always requested that I be at the appraisals on properties I am selling.  I want to know that the appraiser came inside and saw the work we did rehabbing instead of his just doing a drive-by inspection.   I have probably been onsite for 350 – 400 of these on-site appraisals and I am guessing that in 80% of the cases, the appraiser was also an investor, wannabe investor or had a partner or friend in the business.  In most cases the appraiser offered me a referral to a partner of his to do work or outright purchase the property from me.   I always thought this was a conflict of interest but knowing both sides of the industry it never offended me.

If you are considering buying a property, walking through your perspective purchase is becoming more critical in these times because of lenders’ requirements on the appraiser to use the lower or lowest comps in the neighborhood.  Some students have had serious problems with appraisals that were worse than ridiculous, for example $72,000 for a property that even in today’s market was worth $125,000 on a really bad day!

The student seller changed mortgage brokers and eventually got the appraisal he needed to sell his full-rehabbed property at $115,000.  So don’t be shocked at a low appraisal because you can contest the finding.  If the buyer is doing FHA financing, once he applies and a “folder” is opened, your chances of getting the appraisal changed is much smaller to not at all.

Another important lesson here – just because you use an “AS IS” contract does not mean the buyer will have to eat all the deficiencies of the property when he buys it – even if his own inspector does not find the deficiency in his inspection.  Two cases come to mind, the first was a very expensive mansion on the intercoastal that was sold “As Is” and later the buyer discovered horrific subterranean termite damage.  In fact, so much that there was an estimated $2,600,000 in actual repair costs.  The damage had been carefully concealed by repairs by the former owner.  There was extensive damage to the structure of the building and the property had not even been treated for the existing termites.  There may have been cause to look at the original sub-contractor’s insurance who did the soil treatment of the original slab, but the issue at hand was an attempt to cover-up significant damage and ongoing expenses.

The buyer sued the seller and the seller’s attorney just kept whining “As Is” contract, “As Is” contract!  However, the attorney knew the deficiency was so huge as to have warranted disclosure to the buyer before the closing.  I was asked by the buyer’s attorney as an expert witness for the repair estimate.  My testimony was that the structure could not be fixed without spending more than the purchase price (just like the appraiser said to the student mentioned above – except in this case it was really damaged!).  The final settlement was for more than the purchase price and the buyer was allowed to keep the property – a multi-million dollar settlement. 

The moral of this story is don’t assume that an “As Is” contract means you can dump a problem on the buyer.  However, if there is a major deficiency, you can cover yourself by disclosing it in writing to the buyer and give them time to do proper inspections – which is what I have always done.  Yes, some buyers will walk away, but believe it or not, there is always a buyer out there especially at the right price.