“You should be a Real Estate Tycoon,” they said. “There is good money to be made.”

Me: No, I’m super lazy, and I don’t want more work.

“The only thing better than being a Property Mogul is being a bank,” they said. “It’s totally passive.”

Me: OK, I’ll give it a try. What could go wrong?

Real Estate Tycoon

Did I ever tell you about my Rental from Hell?

Over a decade or so, I went from eagerly seeking passive income to money lender to foreclosure expert to rehabber to accidental landlord and back to money lender. I was no longer eager.

To recover the $ I lent I had to foreclose. It was unfit for human habitation, so I had to rehab. To sell, I had to provide financing.

If that sounds like a nightmare, I’m just getting started. (Seriously, it is a good story.)

Be the Bank

One of the golden rules of rental real estate is to choose your renters wisely.

But what if, after months of looking and multiple ads, your choices are an existing tenant with dubious track record (but with a purchase option) or nobody at all?

So I decided to try this whole “Be the Bank” thing.

Incentives

My renter wanted to be a homeowner, to own a piece of property free and clear as soon as possible.

I wanted to have no property, also as soon as possible.

So I proposed a 3 year balloon mortgage, with the verbal commitment that I would write a letter of recommendation after 3 years of regular on time payments. Combined with an improved credit rating, this could be used to shop around for a traditional mortgage.

His counter offer was a 7 year balloon mortgage with a verbal commitment to pay it in full in 7 years. “I guarantee it.”

I was skeptical.

Rent payments had been inconsistent, but I was betting that his Owner Mentality was stronger than his Renter Mentality. To be sure, I instituted contractually obligated late fees: $25 after 5 day grace period, and $2/day thereafter.

7 years is a long time, longer than many marriages. What better way to encourage an early payoff than a financial incentive? Single family home mortgage rates were around 4% at the time. Unconventional rates were closer to 6-7%. We settled on 9%, although I also would have accepted a higher price.

For the day to day stuff, I arranged for a 3rd party company to manage all payments and property tax & insurance escrow. I was now completely out of the loop. Right?

Well, no. It wasn’t so passive.

Chronically Late

The first payment was late by a couple days. This wasn’t unexpected, and resulted in $27 in late fees. Or as I call it, lunch.

Payments were late each of the next 5 months. Come on man! I wanted an IN YOUR FACE notice every time a payment was late, so the escrow company agreed to mail late notices every month if need be. This cost me $2 each time.

Payments for month 7 and month 8 were made on time. YES! Late notices were finally making an impact.

But then… for the next 36 months every payment would be late, usually by just a day or 2 but sometimes by 2 weeks. By now the late fees were really adding up, and payments were no longer having an impact on mortgage principal.

And now… a month went by with no payment at all.

Drama

There was a pattern of behavior I was familiar with from our rental agreement days… skip a payment and then ask for something ridiculous. Maybe he thought this provided leverage… which it kind of did as a renter in a down market who had a garage full of rehab materials. Now it just added fees and back interest to a mortgage with full recourse.

Randomly, a couple months after we closed on the mortgage I received an envelope with a copy of a water bill from 2008 for $300, with no context whatsoever. Some time later I received an email asking if I could reimburse this bill, since it was from before our new arrangement. I declined.

A couple years in, I was asked if I could provide funding for another real estate project he was interested in. “With this one deal I can pay off what I owe you.” I also declined. I wasn’t interested in shoveling more money into this hole.

Now 3.5 years into the mortgage, we have a somewhat heated exchange about late fees. “I’m ready to pay off the mortgage asap, but these fees…”

Always it is “I’m going to pay off the mortgage early, but….” So sure, I would be happy to waive late fees if you pay off the mortgage now. Can you also setup direct deposit like we talked about last time? Just pay 2 days earlier, it isn’t so hard.

Every time I got one of these emails I felt my blood pressure go up. Every time I got a notice that the payment was late I had to swallow some bile. If I ever get an ulcer, I know who to blame.

Now, 6 years into the mortgage and still late every month, things get especially crazy….

X: “We never agreed that there would be interest!”

Me: Please see Exhibit A in this signed and notarized copy of the agreement, and refer to this email thread where we negotiated these terms, and also the annual statement and tax documents you received every year for the past 6 years.

X: I have a habit of signing things without reading them. My lawyers are always telling me not to do that.

A few months ago:

X: I can pay you $42,000 to close asap.

Me: You owe $65k

X: I’m going to declare bankruptcy

Me: Sorry to hear that. Do you want to mail me the keys or will I need to foreclose?

A month ago:

X: I can pay you $60k at closing

Me: OK, I can accept that, as long as the mortgage is paid to date before hand (about 4 past due payments plus late fees.)

X: Sends a weird stack of documents to me and the escrow company, blaming his bank for losing mortgage payments TWICE , accusing the escrow company of intentionally delaying payment to cause late fees, and saying that I owe him over $6,000 that “Jeremy has no intention of paying.”

It’s all complete nonsense.

Included in that stack as proof of on time payment was this:

“Proof” of on time payment

Note that payments are due on the 1st. Late fees start after the 5th. The payment was scheduled on the 9th, but not guaranteed for delivery until the 16th. The escrow company processed this payment on the 15th.

Negotiation, Compassion, & Math

Why would I agree to accept something less than the full contractually obligated amount?

Truth be told I would be best off financially with a foreclosure and resale. Foreclosure in Washington State takes about 6 months, and would cost between $2.5k and $4.5k, fees that would be recoverable in a final sale. 6 months of no interest is another ~$3k, plus some property taxes. Retail price for this property would probably be around $130k. I could always Be the Bank again…

But the bankruptcy threat was always just negotiation strategery. I figured I would pay a nonrefundable $2,500 retainer fee to a lawyer and then reach an agreement once the bluff was called.

I also thought the late fees got a bit out of control. The purpose was to incentivize on time payment. Yeah, that worked. If payments had been paid 100% on time, every time, the outstanding mortgage balance would have been $59,925. It was now near $66k. $2/day adds up when you are 4 payments behind and chronically late. The official tax documents from last year show ~$2,200 of late fees.

And finally, this guy had been living there for 9 years by now. He rehabbed the entire thing. I didn’t want to bring down the hammer of the law for a couple thousand dollars. I guess I’m not the raw capitalist type.

And really…

When I plug all of the dates and dollars into Excel’s XIRR formula, I get a return rate of ~9.5%. 9% for being the bank, and 0.5% for the drama (totally not worth it.) I would much rather have had a payoff 4 or 5 years ago, but what can you do?

What is next?

What’s next?

The direct deposit for the final payoff was just sent to my bank account. I’m now looking to invest in another Real Estate project. Obviously.

OK, no, not really. I’ll be returning these dollars to our stock holdings.

Earlier this year I had increased our cash / bond reserve, a portion of which was slated for foreclosure expenses and assumed loss of income. I’ll be returning that portion into the portfolio as well.

The reduced annual interest income will impact cash flow (irregularly) but open up more room for tax free Roth IRA conversions.

“There is nothing better than having a real estate empire,” they said. For sure, when things are good the cash flow and return can be fine.

But then again, being retired early, traveling the world, living off our completely passive stock portfolio is pretty great, Gary.

My days as a Land Baron are over.

Would you be the bank?