From Riches to Rags, the U.S. Housing Market Crash and Bankruptcy
Politics / US Housing Feb 20, 2012 - 07:06 AM GMTBy: LewRockwell
Brad C writes: My experience with a tax audit, real estate crash, rental house woes, foreclosures, layoff and bankruptcy:
In a nutshell, we went from a 4,000 square foot home, worth more than $1 million, a vacation home, new RV, Mercedes convertible, Jeep, $50,000 SUV, 20 rental properties, a property management company and a great full time job... To living in a modest rental house in the middle of nowhere.
I am a computer guy, have been since 1991. I bounced around a few companies gaining positions and knowledge. Eventually I rode the dot com wave as a security and infrastructure consultant.
In 2000-2001 I had been working for a dot-com company, and at one point had enough stock options to retire at 35 years old, just needed to have the stock vest. But, just before my stock vested, the bubble burst and I went from looking at retiring to looking for a job. I had put all my extra cash into the stock of the company I worked for. So, in addition to loosing my job, my stock options, my retirement and my savings, I also lost my drive for working hard at the “company” and going whole hog as an employee/leader. I was very discouraged.
After finding another job, I decided that I had to try my own way to build a future for my family.
I started buying rental houses in 2002
The first one was very easy. I found a house for $70,000 in a Tacoma, Washington hill top area. I put $2,000 into the house, carpet, paint, flooring, bath fixtures, and a cheap fridge and oven. I was able to refinance it for $100,000 and rent it our for $300 more than the payment. This netted me $27,000 in a little over eight weeks with a $300 per month positive cash flow. I did this same thing about 10 times over the next two years, while still working full time as a computer guy.
As a result this developed into the following activity. 1. Started to sell real estate part time as an agent. 2. Started my own property management company. 3. I "biggered" everything (house, cars, trucks, boats, vacation home, you name it..) 4. Started to slack on my job, did not take opportunities that were offered to me. 5. Started counting the days until I could retire.... again.
By 2006 I was in deep debt, but had a $1 million plus in equity in the homes we owned. It was around this time that real estate sales started to drop off in Washington which was late to the crash. I figured what a great deal everyone else is missing out on. I can surely refinance and pull out more cash like I have been doing for several years. So I purchased three more homes in the beginning of this year. They were not cheap, I was paying $150,000 for a home that was $100,000 just three or four years before.
Another huge thing that happened to us was an IRS tax audit. They found a $500 dollar expense that was supposed to be a loss. This was not a big deal but they opened both 2004 and 2005 taxes to audit. As a result, a $500 dollar mistake turned into a $120,000 fine and back taxes owed.
We battled it out for several months but eventually I had to hire an attorney and we settled for about $57,000 cash.
And yet another thing that happened in 2006 is the re-opening of a low income housing to Section Eight ("Sec8") recipients. this category, mostly for single moms, Sec8 was the bread and butter of rent in Tacoma. They paid high rent and 70% of the rent was paid by the local Housing Authority.
The HA did not get enough interest in clients renting out the new HA homes so, in order to push Sec8 renters into the new homes, the HA started failing my houses on the safety inspection. Which costs me thousands of dollars per house to fix. Then after paying for the repairs, they told the tenant they can move into the new HA homes without any up front expense and would provide new furniture for them, and that they had no requirement to give notice to the current land lord. I had 4 families move out without notice. They left the homes trashed. I decided to get out of real-estate.
We sold about three of the homes and was surprised at the outcome. My tax hit was a bit more, my fees were a bit more and as a result I felt as though I gave the house away. It was not a good feeling after putting in so many hours to fix them up. I certainly did not get any money in my pocket by selling them.
At some point, I learned about renting houses out in the “Clean and Sober” model. I started a clean and sober housing company and rented beds rather than the house. My main client was the Department of Corrections. They provided tenants recently released and on probation for drug convictions. This required me to cover all utilities and furnish the houses. I also had to put coin op laundry machines in all the houses. In return I received $315 dollars per month per tenant. A five bedroom house could house ten tenants if at full capacity. However, this never happened, they were always about 60% full.
I was still cash poor. In 2007 I refinanced most of the rental home in order to pay off the IRS, repair damages to many of the houses, buy coin op laundry for all the houses, pay for the expenses of the new company until the homes were furnished and occupied by new "clean and sober" tenants.
2008
At this point, house values have fallen so much that selling these homes was impossible. I had refinanced them and did not have the equity to sell and pay the fees and taxes.
The clean and sober renting scheme never quite paid for the payments of the homes. If I had not refinanced them in the “third” place, the payment would not have been as high.
I was running out of cash very fast. The only income I truly had at this point was my job, but just my monthly take home pay would not even cover the house payment and utilities of my primary residence. I still had two car payments, RV payment, vacation home expenses and food. But above these, the expenses for 18 investment properties that were not performing.
I decided to take out a second mortgage on one of my rental houses.
With the new cash, I was good for another year and tried my hand at flipping houses. Which turned out to be a horrible mess. I had done a few in 2003 and 2004, and they had made me some quick cash. But this next one destroyed me. The details are another story in just itself, but to sum it up. I paid way too much for a home. It had huge issues that I was not aware of, and I signed away my rights to find out this information. The worst part is, that I used a business partner who had become a friend of mine. I ended up taking out a second mortgage on each of my four best houses.
The flip house got red tagged while working on a foundation repair. While going through the violations and getting a permit, they decided that since I was adding over 50% more value to the current zero value of the structure I must bring everything up to code. For a 1920s home, this means wiring, windows, plumbing and worst of all septic. The septic was over $30,000 alone.
Midway through 2008 I was out of cash again and mo more capacity for more loans on the rentals.
Then the mother of all problems happened. A contractor who had been developing a small tract of homes in the Tacoma area was not able to sell them or rent them. So, he went to my clean and sober homes and invited them to move into his new clean house. No rules, no drug screening and half the rent payment. So most of them took him up on it. I had four houses empty of all but one tenant in the same day. This is a direct violation of their probation, so all of them ended up back in jail within 48 hours, however this ruined my cash flow and buried me again.
I was really in deep now.
My last ditch effort was to refinance my primary home. I used a different money guy because I was so embarrassed of the mess I was in and I was afraid that my flip partner would want all the cash out of the re-fi to get back some of what he had put in. My intention was to complete the flip, sell it and fix the mess.
At the last minute signing the re-fi, again had a poison pill. The truth in lending (TIL) report, showed that my payment went up a little from what the loan man had told me, but the interest rate was up much higher. They tried to hide it by not including the taxes and insurance. (My property taxes were over $1,000 per month.) Also, the fees were bigger. And it went from a five year ARM to a three year term. I thought I would get $30,000 back but only got $26,000. I didn’t want this deal, it was pure bait and switch predatory lending. But, I had no choice, I needed the money now, So I signed the deal.
At this point, my fate was sealed.
There was not enough money to complete the flip house and it was later condemned. The county not only condemned it, but forced my partner to pay for the removal of the home. He ended up with a worthless un-buildable vacant lot that he paid more than $200,000 for. I do and always will feel horrible about this.
We were at the point where we had to stop paying on something. We decided to consider which homes we would keep and which homes we would let go.
The rental houses and apartments would not work, they were all in Tacoma in areas. The only one that would work is our vacation home. Which was 100 miles to the east and only accessible by snowmobile 4-5 months out of the year, but the payment was manageable and the home still had some equity left. Also, we would not have to face the people we knew who would watch my life go from riches to rags. So, we decided to move to the cabin.
We didn’t know anything about foreclosures or time frame of what happens so we planed to move ASAP. We made one house payment on the new re-fi. That was all.
We moved
My commute went from 45 minutes to 90 minutes, but I was okay with that. We loved the cabin. With working 2-3 jobs since 2002, we rarely went on vacation or took time to do anything as a family. When we purchased the cabin as a vacation home in 2005 we started to become a close family. So we looked at this as another adventure. We started to prepare for the events that were about to happen.
As we moved we had the primary house up for sale. After a few weeks I called the bank and found they would not talk with me unless I was 90 days late. Once that 90 days hit, they started calling me. The person on the other end of the phone was not a knowledgeable person, yet they said they were the decision maker on my loan restructure. I realized they were just pumping me for information. I thought it was strange that I must fill out all this stuff, when I had already gave them when I got the loan in the first place.
Through all this, I had no one to talk with. Apparently I was the first person in my circle to go through this. I felt about 3f tall and went rather recluse and sad all the time. Moving was a chore. Saying good by to neighbors was hard and embarrassing. Lots of unspoken questions. How could a young guy go from being on top of the world, to nothing in just a few months. At first we did not tell anyone what was going on, but after a few awkward conversions, I started to tell the whole story, or at least what the story has been up to that time.
Lessons Learned: We went from a 4 car garage, 4,000 sq. ft. home to 2,000 sq. ft., no garage. We had so much stuff it was crazy. We did not have a garage sale because we were embarrassed about our situation. I ended up giving away stainless steel appliances, riding lawn mowers, patio furniture and lots of house hold furnishings. We just wanted the house empty. We certainly should have had a garage sale, we gave away thousands of dollars worth of stuff.
We also had to figure out how to manage living in a snow country a home in winter. We would be snowed in 4 to 5 months every year. We needed to stock up on food and supplies or end up making multiple trips up and down the steep one mile road on a snowmobile loaded with groceries. After having the home as a vacation cabin for a few years prior, we knew what was coming and decided to stock up and be ready, We also had to add a wood stove, a propane stove and cut several chords of wood. We also wired in a generator and a way to store extra gas for it. We basically took care of our family needs first and would figure the bank stuff later.
As it turned out it was an adventure.
After moving and living there for five months, the winter set in and we were snowed in. Then, I received a layoff notice. The last few years of playing real-estate mogul had caught up to me. When they looked at the entire group, I had gone from a leader, to a loser. I was now the weakest person. I did not tell anyone what was going on us now. Sure, I was a big mouth when times were good, bragging about retiring early, telling them I live in a house next door to the vice president of the company (which I really did). “Pride cometh before a fall” and it was a big fall. I had just eight weeks before I would be canned.
Lessons Learned: Now up till this point we were still running our rental homes. With hind sight, we should have stopped paying the rental house payments when we stopped paying the primary house payments.
Enter the lawyers
I already knew that we were going to lose our McMansion to foreclosure, and now I was going to loose the 18 rentals to foreclosure as well. I also knew I would have a few months of “free” money while I was waiting for the foreclosures to take place. I figured I would still collect the rent and not make the rental house payments. Since I was going to get canned at work I had to be sure that I made this one time free cash go to good use. I also made an appointment with a bankruptcy attorney.
Lessons Learned: Be careful how much you tell your attorney up front. They write everything down and never forget what you tell them, so you really need to ask them questions and not have them ask you. As a result, I would have liked to use the first attorney I talked with, but felt that I had to have time to “prepare” for bankruptcy. I needed answers, not the kick off to starting the process.
Disclaimer: All of this is my experience, from my view point, check the laws and rules in your area for the facts. Also, keep in mind that I have not lied or tried to “get away” with anything, I simply needed to know the rules so I can stay within the rules. Some say I take advantage of the situation, and I must say I have. Only a fool would not try to make the best out of a bad thing.
Lessons Learned: I have found that the attorney will just tell you what you need to know and not much more, after all they get paid by the hour and they can’t read your mind. They are the professional in the room and you are not, and up until a year or two ago, most of their clients were plain idiots. The best thing that worked for me was to study the heck out of my situation then ask the attorney if what I understand was correct.
Initial questions
1. Can I collect rent even though I am not paying the mortgage? YES. The house was still mine, I was just not up to date with the payments.
2. Do I need to tell the tenants what is going on? NO. They are renting from you on a month to month basis, either party has only a 20 day notice to terminate the agreement. If it’s a lease, the lease is null and void when the house changes ownership.
Lessons Learned: The attorney didn’t understand these questions. They think that you would not receive any money from rent and if you did get any money you would pay what bills you can. Understand the goal of the bankruptcy laws. The goal is to have you pay off as much as you can. Only if it’s near impossible do they let you off the hook.
3. When can I declare bankruptcy? After your rental houses are foreclosed on, you cant keep any investment real estate.
4. Can I keep my house? YES, maybe...
Lessons Learned: Again, most people are down to the nub with no income. So, some of these questions are new for the attorney.
YES, but do you want to? if its underwater, it will not come back for 10+ years. If you have more than 30,000 in equity, no you can’t keep it. If the payment is significantly higher than the going average housing expense for your area, then no you can’t keep it.
5. can I keep my cars? YES/NO you may keep two, the value must be under $3,000 each. However if you are going chapter 11, you can keep a more expensive car if you have no equity in it and the payments are low.
Lessons Learned: The task is to have you pay off as much as you can, if its better in the long run (5 years) to have you keep the car you have, and make the payments rather than save up for another $3,000 car, then OK.
6. Wedding rings, furniture, TV, stereos ,and stuff? There is a dollar amount you are allowed to keep. if you have valuables, extra cars, boats, rvs, motorcycles.. you need to get rid of them ASAP.
7. What is the time frame of looking at my finances? The court will want six months worth, but your attorney wants six months worth from when you start talking with them. So in our case, it was over a years worth of history. This is why you need time to clean up your history. This is why we needed to understand the rules.
Lessons Learned: The attorney is putting their job on the line when they represent you. So they will not lie or even allow anything that may be slightly under the table. They will need all the information and they will not hide anything from the judge. I know we hear attorney/client privilege on TV, and yes, that does exist, but they will rather just quit and not represent you. You are just another client, you are no O.J. Simpson. Also keep in mind, you are going to the courts on your initiative, nobody has asked you to show up and go bankrupt, you are asking the court for bankruptcy protection from your creditors.
8. Can I give stuff to my family to hold until I am through BR? NO, this is fraud. You need to sell the items and use the money for the good of your situation. (Costco, shoes, gasoline, car repairs, tires, cash to spend because all of the above no longer takes your checks.)
9. Should I pay a little on each bill? NO, if you are planning on having that debt dismissed, pay nothing at all.
10. Can I pay my grandpa back the $10,000 he gave me to learn how to weave baskets? NO, that is called favoritism, if you do this, it’s big trouble. They can go after grandpa and that may be worse. Pay grandpa back by showing him you have learned your lesson.
© 2012 Copyright Brad C - All Rights Reserved
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