Tales from the Trenches

In a previous Tale, we reviewed the calamitous and stomach turning events at the Penhorwood Condominium complex in Fort McMurray, Alberta. Our review looked at events occurring in 2011, but in 2014 things really came to a head. I thought this was serious enough to reprint some our previous Tale, and then follow-up with a discussion of how the circumstances evolved. Read on and be very aware that some condominiums have ultra-serious issues.

Download the audio file HERE and the text/handout HERE.

2011 Summary:

The disaster at the Penhorwood Condominium Complex in Fort McMurray is another graphic illustration of huge potential problems in a condominium purchase. In March of 2011, on a cold winter evening just before midnight, all residents were ordered to evacuate on 30 minutes notice. The Condominium Board had requested the evacuation order after receiving an engineer’s report fearful of a disastrous foundation collapse.

Fingers were being pointed everywhere. The Condominium Corporation blamed the builders and the developers, the Regional Municipality of Wood Buffalo, project engineers, safety codes officers, and the architect. There had already been a lawsuit in 2007 that the Condo Corp had launched against the developer, which was based on a previous engineer’s report noting numerous deficiencies. There had also been a $25,000 per unit special assessment related to earlier problems. Statements of Defense denied all allegations and nothing had been proved in court.

2014 Update:

The Edmonton Journal published an article describing how the Penhorwood owners had been ordered by the regional municipality of Wood Buffalo to demolish all the condominium units. Those 300 residents evacuated in the middle of the night in 2011 had not been allowed back into the condominium complex. There had been talk of repairing the damaged units, but nothing came of it. The Edmonton Journal article says that the regional municipality threatened fines of up to $100,000 and a further $1000 per day and/or imprisonment not exceeding six months. In follow-up articles, the regional municipality has said that they never meant to threaten residents and would never impose those fines or try to put anyone in jail.

However, since the condominium owners have been fighting the demolition order for a couple of years and have said they cannot afford the costs of demolishing, the regional municipality says they will now do it. Christine Burton is president of the Penhorwood Condo Association and she says that the regional municipality will file a caveat against each unit title. They intend to recoup the cost of demolition when the land is sold. Demolition cost is approximately $100,000 per unit.

Remember that every owner will now lose all the cash that they put into each unit purchase, be responsible for their mortgage, and owe a further $100,000 demolition cost for each unit they own. I don’t know the original purchase price of all the units, but I expect minimum losses for each unit owner will be in the $250,000 range.

On their part, condominium owners continue with their $60 million lawsuit launched against 28 defendants including the municipality, developers, and construction companies. This is the worst condominium disaster I have ever come across!!!

Due diligence, due diligence, and more due diligence!

I made many suggestions in the first Tale about Penhorwood, there is also my Tale “Condo Reserve Fund Studies,” and you can take a look at the CMHC’s Condominium Buyer’s Guide.

Contact Barry McGuire now. Alberta real estate needs an Alberta lawyer.

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“High Risk Area” image by Howard Lake used under CC Attribution Share-Alike 2.0 Generic.

When a qualified tenant wants to be a homeowner, but can’t get a mortgage, investors can offer him or her a lease-option. This creative investment strategy is also known as rent-to-own. The trick is doing enough diligence on the tenant to make sure that they will be able to qualify for a mortgage at some point in the (relatively) near future. It also helps to get insurance in case something goes wrong. The tenant pays a non-refundable sum of money for their lease-option, and the whole deal can provide an excellent return-on-investment (ROI) for real estate investors.

Download the audio file HERE and the text/handout HERE.

The lease-option, often referred to as ‘rent-to-own’ or RTO, is a popular creative real estate investment strategy. The essence of this approach is finding and qualifying a tenant who would like to be a homeowner, but for various reasons cannot immediately qualify for a mortgage. This is where the creative part of our strategy comes in. As long as the tenant has the ability to pay a solid chunk of option money (typically not less than 5% of purchase price and better to get more), you can start on the other parts of what we like to refer to as ‘qualifying a tenant.’ Your focus is doing enough diligence to be confident that the tenant will be able to qualify for a mortgage in the future so he or she can buy the property.

Below are the RTO experiences of a graduate from our Deal-Ready Documents Focus Workshop. In his own words:

Here’s a really great story that a colleague shared with me. It brought home a few points I think we can all learn from.

This colleague, I’ll call him Joe, signed a new tenant buyer to a nice clean property in an older neighbourhood. It was a character home in great condition, and the tenant—a single man with a few credit history issues—seemed like a great guy.

Joe exercised his due diligence by checking out the tenant’s credit history, getting him to sign off on a letter stating he understood the parameters of the RTO deal, and making sure there was a good chance he would be able to successfully complete the lease agreement and act on his purchase option.

Over a year went by and all seemed in great order, but then the problems started. It became difficult for the tenant to make his payments on the agreed upon schedule. He just needed a bit of time, he said. Understanding that everyone runs into problems from time to time, Joe agreed to wait for the payment. The waiting stretched out, and the rent fell into arrears. The tenant was warned about the consequences of his actions. Nothing changed.

Joe went over to the house to speak to the tenant and collect a cheque. He says he nearly fell over when he entered the house. It was trashed. A once lovely character home was now like something out of a horror movie: holes in the walls, piles of trash, and filth caked on every conceivable surface. The house was unlivable and the only recourse was to evict the tenant.

The drama didn’t stop there. Although Joe had the non-refunded lease-option monies, they were insufficient to cover the thousands of dollars in repairs. His insurance policy would not cover the repairs.

The house is now repaired, looks fantastic, and has a really great family living there. Even better, a few hard but important lessons were learned.

Does this story turn you off lease-options/RTO? It shouldn’t. The stats say that 60% of RTO deals close (meaning the tenant actually buys the property) with our members achieving 40%-50% ROI over a typical two-year term. This leaves plenty of room to add a joint venture partner and offer an amazing 20% – 25% ROI to them. For deals that don’t close, positive cash flow during the lease term and a solid, non-refundable option payment are still good results.

Contact Barry McGuire now. Alberta real estate needs an Alberta lawyer.

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“3D Realty Handshake” image courtesy of Scott Maxwell. Used under Creative Commons Attribution-Sharealike 2.0.

The foundation of real estate investing is to buy and hold property. Sometimes, however, opportunities come along that require a different strategy. A highly motivated seller with a low/no equity property could be approached with an Agreement for Sale. This is both a creative real estate investment strategy as well as a type of legal document. In this Tale from the Trenches, our investor was able to put down very little money, but still got control of the property through seller financing. Despite the difficulties of Agreements for Sale, they can be very lucrative if handled correctly

Download the audio file HERE and the text/handout HERE.

Two years ago our member ran across an opportunity in his community group. Mom and Dad owned a nice, well-managed condo with a great reserve fund, but their marriage was falling apart. Their CIBC mortgage was in arrears to the tune of $10,000 and condo fees were $4000 in arrears. Dad suffered from a physical disability with no ability to generate income. Mom had taken a job in South America and Dad remained here in Alberta. At the time, condo prices were depressed. The sale price was $200,000. There was only about $10,000 equity in their condo, all of which would be taken up by arrears.

That situation makes it impossible for the sellers to list with a realtor unless the sellers were prepared to pay real estate commissions out of their own pocket. These sellers needed to sell without a realtor. How does an investor creatively purchase this property from a motivated seller? Creative doesn’t mean applying for a conventional mortgage with the usual down payment. The best you could do is 15% down with a Canada Mortgage and Housing Corporation (CMHC) insured mortgage and on a purchase price of $200,000 that’s a $30,000 down payment. And, even in Alberta, mortgages are not assumable without qualification.

The question is, how could our member, for as little money as possible, get control of this property using seller financing? The answer is, our member employed a real estate strategy known as an ‘Agreement For Sale,’ abbreviated as ‘AFS.’

Formerly in wide use across Canada and still in use in Alberta, an Agreement For Sale or AFS is a strategy where the buyer takes control of the property and uses seller financing. The words ‘Agreement For Sale’ are both the name of the strategy and the name of the security document that the buyer gives the seller.

The essential first part of an AFS is that even though the buyer takes full possession of the property and is responsible for taxes, insurance, and maintenance of the property, the title remains in the seller’s name. Sellers love that title remains in their name when they are providing the financing.

The second essential part of an AFS is that once you have paid your deposit, if any, the seller is your lender for the rest of the purchase price. The seller may have a large mortgage already registered against the property, a small mortgage, or no mortgage at all. The amount of the seller’s mortgage, if any, is usually not a concern to you. You are not assuming the seller’s mortgage. He or she is your bank for whatever money you still owe. What the buyer owes to the seller is called the ‘unpaid seller’s equity.’

There were lengthy negotiations extended by Mom being out of the country. It took a long time to get an arrears statement and any cooperation from the foreclosure lawyer. Finally, we got the arrears statement, which confirmed the existing mortgage to CIBC was $10,000 in arrears. It was time to write the offer.

Now, in many cases and including this Tale, after paying the deposit/cash portion, the amount you owe the seller and the amount the seller owes his lender might be exactly the same in dollar value. That was the situation for our member in what we describe as a ‘low/no equity AFS.’

Using a standard Alberta Real Estate Association (AREA) purchase contract and a specialized AFS schedule, he and I wrote up the contract. Lucky for us, Mom had to return from South America so during her two-week visit, we got the contract signed and she went to see a lawyer that I was able to recommend as being familiar with AFS.

The AFS strategy does not work well with lawyers who don’t understand or haven’t worked with AFS. Always make sure your seller has a lawyer who understands and who will cooperate in an AFS transaction. I sent a draft AFS document to the seller’s lawyer. We finally got the AFS details worked out, although we didn’t get everything we wanted.

One ideal AFS component is a power of attorney (P of A) from the seller to the buyer leaving the buyer in full control of the property. The P of A is very useful for a buyer who might have to deal directly with a lender, municipality, or uncooperative post-closing seller (no more skin in the game). The seller did not want to give the P of A on the advice of their lawyer, which later caused our member trouble. However, we did get them to sign a transfer of land to be held on file along with a management agreement.

Having the signed transfer on file facilitated the situation two years later when the AFS matured and our member had to refinance to pay the full purchase price or sell to third party. A management agreement is not as powerful as a P of A, but still useful. And so, with much backing and forthing and time and stress the deal closed and our member now controlled the property. In the end, our member paid the seller $16,000 representing the mortgage arrears, condominium arrears, and $2,000 for the seller’s lawyer’s legal fees.

… Wait a minute, if the seller’s equity was only $10,000 should our member have paid $16,000 cash?

Over the next two years our member battled with CIBC on the question of making the underlying mortgage payment. He didn’t want to simply deposit his AFS payment to the seller’s bank account because the sellers were in financial difficulty. What if they received our member’s payment and then didn’t make their mortgage payment?

CIBC didn’t want to deal with our member because of the foreclosure history. They didn’t like and would not abide by the management agreement. Similarly, the condominium corporation was not cooperative. However, our member finally worked out the details of ensuring the sellers underlying mortgage payment was made, dealt with the condominium corporation, and installed a very satisfactory tenant.

Fast forward two years later and our member wanted to sell the property. The AFS was maturing and the condominium market had recovered. The next issue to deal with was that lenders and title insurance companies have tightened their rules to disallow skip transfers. They want the seller’s name on the contract to be the same as the name on title.

The sellers wouldn’t cooperate so our member negotiated financing with Calvert Home Mortgage. He transferred the property to himself, put on the new mortgage, and paid out CIBC. Now, the title was in his name and he listed the property, which sold quickly for $268,000.

A rocky, stressful road… leading to a sweet profit. Even allowing for substantial extra expenses and real estate commission, our members annualized return-on-investment (ROI) was 280%.

Contact Barry McGuire now. Alberta real estate needs an Alberta lawyer.

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“House, Property, Real Estate For Sale Sign” image by Mark Moz used under CC Attribution 2.0 Generic.

It doesn’t matter who you are working with in a real estate deal, you still need to do your diligence. This means asking questions and reading the documents—even if dealing with a friend. Don’t assume an expert is infallible either; professionals can still be wrong or make mistakes.

Download the audio file HERE and the text/handout HERE.

Here at Investor Lawyer we talk a lot about diligence. We harp on how important it is to undertake enough diligence to say, “I have done due diligence.” When you can confidently say, “I have done my due diligence,” you can then make a buying decision. Sounds easy. Find a property or investment, work your way through the diligence items, and make a decision. Like all theories, putting it into practice sometimes has speed bumps.

One major speed bump on the road to due diligence is the presence of an ill-informed friend or so-called expert. We all tend to believe what our friends and experts tell us. Don’t do it!!! Here, in his own words, is one investor’s account of a couple of friend/expert situations (slightly edited for flow).

Hi Barry: RRSP Loan inquiry

Long time no hear, from me that is, as I’ve just finished listening to you on “Tales From The Trenches!” Just last night, I sat down with a paper, pen, and AREA contract and listened to your detailed explanation of this contract you went through in March of 2009. There’s always something else that makes us go…..oh wow, I didn’t hear that all the other times I’ve listened to it. I’ve made myself a word document that is now on my USB and will accompany me on all offers. Of course you know that you make an educational impact on us, but please don’t forget that all those recorded meetings are still making an impact on us – A BIG thanks for that!!!

I’ve done a couple of RRSP loans already with 2 REIN members and wondering what a typical time limit would be to complete the documents from your office? I know there will be a lot of questions, but I’ll fill you in the best I can for now.

This would be a loan to a friend who wants to buy an existing Halal grocery store.

That’s all I can think of at the moment.

Here’s my reply:

Hi there and thanks for those kind words.

With respect to the RRSP I note that you have done a couple already. If you have a lawyer that you have used and you were happy with the service and the fee, then you may be best served by continuing to use that lawyer.

As to the loan itself, it has to be what I believe the CRA calls a “qualified investment.” I don’t think a straight loan is a qualified investment. What security is he giving you for the loan?

Cheers, Barry

To: Barry McGuire

Hi Barry:

Well, in my due diligence stage, my friend could not give me any security, as I asked to put the loan against his home and he couldn’t do it because he plans on building a new home in the new year. I simply told him, I need something to back this loan up and it fell through. We currently own a Rent-To-Own property together and he asked to use that as security and I said no, I want the books clean when it comes time for our Tenant Buyer to purchase, which is the end of the year.

I did ask him a lot of questions and it’s obvious he has not done any homework on this grocery store. He told me that the seller wanted more time with his family, as the business was eating all his time up. I then asked my friend to go and sit with the current owner, if his motivations are what you told me, then maybe the owner can loan you that money and work it into the deal.

I’ve been trying to loan out more RRSP money and it amazes me how many REIN members don’t expect all the questions that I ask. I’ve had one member in Ontario, that when I told him I read the offering memorandums from front to back, he never even sent it. Another mortgage broker sent me a potential lending opportunity and the property owner didn’t even own the land, just the trailer on it, so I asked, where would my security come from, if this trailer got moved and he had no answer. I thought, how can a respected mortgage broker send me something like that. Either I’m reading too much into it or just not experienced enough—I’m going with the “reading too much into it” part.

So, there you are! Our investor dealt with a friend and co-investor who wanted to borrow money but did not want to provide any security. Too many people in this situation would have done this on a handshake or perhaps a promissory note. When the deal went bad because the friend hasn’t done any diligence on the grocery store and has no experience in the grocery store business, both the loan and the friendship would be gone. Demand paperwork, then read it thoroughly, twice or three times. If it doesn’t make sense, ask more questions.

When experts like the mortgage broker send you deals to consider, pay no attention to the status of expert. And, keep reviewing your Tales From The Trenches and written material. Tales are ‘Gems’ that will save you time, trouble, and a lot of money.

Contact Barry McGuire now. Alberta real estate needs an Alberta lawyer.

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“Exercise That Diligence” image by Alan Levine used under CC Attribution 2.0 Generic.

Buying and holding single-family homes is a great strategy for anyone starting out in real estate investment. Many people eventually get into multifamily properties, which builds on the experience of basic buy-and-hold. Becoming a developer is a very different type of strategy and is much more difficult. The rewards can be worth it for a senior investor, but there is also a lot of risk involved, and so development should be approached cautiously—if at all.

Download the audio file HERE and the text/handout HERE.

The bedrock strategy of the Real Estate Investment Network (REIN) is buy-and-hold. That’s what we teach and that’s what most investors employ as their main strategy. We think it takes purchasing at least three buy-and-hold properties to give anyone a basic understanding of this most straightforward of strategies.

Once you start moving up to multifamily there are other wrinkles and crinkles as you work your way through the duplex, fourplex, sixplex scenarios and then into the 20-suiter (or bigger!) apartment buildings. The strategies for multifamily purchases are a little more complex. But, and this is a big but, moving from any of these strategies into what we call “development” is a totally different kettle of fish. Investors who insisted that experience and success with buy-and-hold strategies prepared them to be developers have lived both to regret that notion and the accompanying huge monetary losses. Let’s look at some examples.

Our first investor found a piece of property near a major Alberta city and felt that the property would make good acreage subdivision. He had a partner with a fleet of earthmoving equipment and lots of experience. He negotiated with the relatively unsophisticated owner subject to financing, permitting, and subdivision requirements. Many condition dates came and went without conditions being removed. Still, the seller and our investor stumbled along.

The transaction eventually went unconditional, but ultimately failed when our investor could not satisfy his lender’s tough requirements for project advances on the mortgage.

Our investor failed to properly assess or understand:

This investor believed, wrongly, that:

He was wrong and his company is bankrupt.

Our second investor invested in the debentures (promises to pay secured by company assets) of a development company doing a residential development in a small, southern Alberta town. The debenture was issued by way of prospectus and properly done through the securities commission.

The developer badly underestimated the attractiveness of his project and kept running out of money. Presales were not good. The developer kept returning to the debenture holders asking them to postpone their first security interest to new money from other lenders. The developer finally washed his hands of the project and the debenture holders have had numerous committee meetings to see how they can try and preserve their investment.

It was difficult if not impossible for the debenture holders to analyze whether the developers had a chance of success with his project. It appears that our investor and other debenture holders relied on Alberta’s boom in an attractive area to assure themselves that the project would move to completion. They were wrong and our investor is holding the bag along with other debenture holders.

They may never be paid or at pennies on the dollar.

Our third investors were a husband and wife team with very high paying jobs in Alberta’s oil patch. They met a developer who had moved to Alberta from another province and started on numerous Alberta real estate developments. For due diligence, our investor checked in the developer’s home province and found the developer was well thought of, with lots of experience.

Our investors put up $200,000 for a hazy, unsecured interest in one of a number of developments and a promise of large profits. The developer insisted the investment would be hands off with our investors having no say. Our investors subsequently noted that the developer was short staffed and undercapitalized for the projects. Later on, it was discovered that the developer was mixing funds from various investors in various projects.

Our investors are now embroiled in a court battle looking to retrieve their $200,000.

Our fourth investor wanted to graduate from buy-and-hold and morph into being a builder/developer. The plan was to purchase a lot and build a fourplex. He found a lot zoned for a duplex in an area full of duplexes and fourplexes. He understood that he couldn’t build a fourplex, but thought that was just a matter of getting a variance from the city planning and building department. The street already had some fourplexes didn’t it? So, the lot was bought, and the deal went unconditional.

What our investor didn’t understand was that unless the zoning allowed a fourplex as either a permitted or a discretionary use, a development officer has no authority to issue a permit; s/he has no authority to change the use. The word variance applies to the development regulations that apply to a particular zone. In other words if the zoning allows a fourplex but requires a certain side yard, then, if your side yard is deficient, the development officer can give you a variance with respect to the side yard. But, s/he still can’t change the use.

Our investor overpaid for the lot, and so he will now have to build a duplex and hope to break even, or sell the lot and take a loss.

Contact Barry McGuire now. Alberta real estate needs an Alberta lawyer.

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“High Risk Area” image by Howard Lake used under CC Attribution Share-Alike 2.0 Generic.