The Hidden Inventory Only Experts Know About w/Jake Flothe

Dave:

Hey everyone, it’s Dave. Welcome to On the Market. Today I’m joined by James Dard. And James, thank goodness you’re here today because we are getting into a part of the real estate investing world that I truly know nothing about. We’re going to be talking about Receiverships, and you were really excited to talk about this topic. Why do you think this is important for our audience to know

James:

Right now? The deal flow is really hard to find, and as investors, we have to shake every branch right now to find that deal and what we are seeing, or at least what we’ve been seeing, is we’re buying a lot more product that’s from investors that’s half stabilized or half renovated or investment deal that went bad and the lenders are trying to dump it off. And so we’ve been able to find quite a bit of inventory through Receiverships, something that a lot of investors just kind of bypass, but you have to look at all these deals because some of the best deals we’ve ever done have been bought out of receivership, and they’ve also been some of the smoothest deals we’ve ever bought as well. Cool.

Dave:

Well, I’m excited to learn about it and obviously something about buying and selling with receivers, James, from your personal experience, but to help us understand this topic, we’re bringing in an attorney, Jake Flothe, who is a receiver and has really intricate knowledge of the process side of receiverships, the legal things that you need to consider as an investor and has some tips for you if you either find yourself in a situation where you need a receiver or as a buyer if you want to potentially buy a property in receivership. So with that, let’s bring on Jake Flothe. Jake Flothe, welcome to On the Market. Good

Jake:

Morning guys.

Dave:

Jake, as you’re going to quickly discover, I know absolutely nothing about receiverships, so let’s just start with the basics here. What is a receivership?

Jake:

So a receivership is a court process where a receiver is a person and it could be an individual or a legal entity that is considered a person, but it’s a person that’s appointed by the court to take control of the property of somebody else and administer it typically for the benefit of creditors, sometimes for the benefit of the equity owners in the case of a partner dispute.

Dave:

So the court dictates that for some reason a property needs to be handled or handed over to this stewardship to a receiver. You just said partnerships are one example of when that might happen. What are some other examples of why a receiver might get involved in a real estate deal or transaction?

Jake:

A large portion of it is debtor and creditor instances. So when you have a debtor that’s not paying as they agreed to or the collateral is worth less than the debt and it needs to be liquidated.

Dave:

Okay, got it. And so is this then in lieu of a foreclosure or how does this sort of fit into the foreclosure world?

Jake:

So it’s an alternative to foreclosure, similar to a trustee sale. You can sell it through a receivership and wipe out subordinate debts, but different from the trustee sale is that we can actually get the properties marketed and expose them to the open market where people can obtain financing and conduct due diligence so they can make an informed purchase and we can get a higher, better value than is typically obtained at a trustee sale.

Dave:

So just so I understand, in a trustee sale it has to be sold sort of privately, it’s not listed on the open market, people have to bring cash, but using a receivership, it sounds like you take that property and essentially you can list it on an MLS or you go to private investors and that allows potential buyers to seek traditional financing and I guess in theory that would allow the seller or the property owner to receive more because there’s more competition for the property.

Jake:

Correct. Yeah, and in addition to that though, everything’s overseen by the court. So say we do market a property and we get an offer that appears acceptable, we’d file a motion with the court, give notice to the creditors, to the equity owners, to all parties and interest, and they’d have at least 30 days to come to court and object or continue the bidding process and get a higher offer approved by the court.

James:

And as far as an investor goes, a lot of times you’re getting the same result as you would many times at the trustee sale. If they take it to auction, it’s a first position deed of trust, you can bid on it and it’s going to clear out a lot of the other debts except for sometimes the IRS lien can follow or a couple other types of liens. But the big benefit for investors to buy a receivership over the nose trustee sale is you get so much more due diligence on those properties because you can go inside them, you can run your feasibilities, you can have an elongated close rather than just a quick bring your cash to the auction and write a check. And so for an investor standpoint, it’s very beneficial because you just have that little bit more time to massage the deal, look at it and have some more time to make adjustments on offers in case the debtors come back.

James:

Whereas that trustee sale, you’re just bidding and you don’t know what your price is going to be when you go down there to bid. And then you also don’t know what’s going to happen with the possession, which is a really big deal in today’s market, especially for those metro cities where you have longer eviction laws. So Jake, when you are working with investors, a lot of what the product is that’s inside that you’re working with, they’re usually properties that are either over levered or have some sort of symptom of distress that put them into that situation, whether it’s repairs, it could be an investment gone bad on most of the properties that you guys sell as receivers are most of or is this stuff that typically needs to be closed in cash?

Jake:

I’d say that most of ’em are financeable. There are a lot of properties that are occupied, whether it’s by an owner or a tenant, but we have a lot of habitable buildings that are up to code. The market’s open to everybody. It doesn’t have to be somebody coming to the courthouse steps with a cashier’s check and a hard money loan to buy it from a trustee. They can get a traditional financing and be an owner occupant after that. Does that make sense?

James:

Yeah, it makes sense because there’s all different types of financial situations that happen, right At the end of the day there’s financial stress and people need to clear off their debt and in order them for them to do that, they’re selling their property or they’re offsetting those costs with trying to cover as much as they can. And then essentially you’re doing a short sale on the rest of the debts and getting them to accept the payoff, but it’s going through more of the court process rather than a traditional short sale. Like in 2008 and 10, we went through a lot of different short sale processes where we’d worked directly with the lender submitted in our offer and then you’d be negotiating directly with that lender getting appraisals in the way that they want to check the value. Can you touch a little bit of how it’s different from the traditional short sale to what you guys do? Because as a buyer and investor, I’ve always felt like buying a receivership sale via short sale is a lot cleaner than buying through a lender. It gets done a lot faster, it seems to move quicker. And it seems like the debtors move a lot faster when a receiver’s involved.

Jake:

That’s right. It is a lot smoother. Back in the early 20 teens I was involved with a number of short sales. It was a slow and tedious process getting authorizations and continually talking to the bank and negotiating. But with a sale and the receivership, you don’t necessarily need this secured creditors agreement or acceptance of a lower offer because the judge is the one that decides whether or not an offer is ultimately acceptable and will be forced through. What we do is when we market the property, we work with trusted brokers, we do our own market analysis and determine what a fair market value for the property is. And typically creditors or the creditors council are pretty savvy to the receivership process. We just get a lot smoother and quicker cooperation and get closed a lot faster than we had previously with traditional short sales

James:

Because that traditional short sale can be a very long painful process. We had some that we did, some are years where we’ve been negotiating a short sale for years because once they hit that, a lot of states they have a certain amount of time to sell a property at the auction and then they have to refile. And it would be like this short sale process that we’d be doing, going to the refiling, updating the financials every month, getting that over to the bank and it could take years. There was one, I think we closed, it took over three years to get it closed and it really didn’t make a whole lot of sense. The debt kept compiling on it, but it was just that process with the bank and how slow it was, and if the appraisal was even off by 2%, they wanted to restart the process. And as a buyer goes an investor, we’d like buying receivership sales a lot better because smoother, they’re quicker and you can kind of depend more on your offer price or at least you get your answer back a lot faster.

Jake:

Right, and I’d say that there are fewer variables because one of the things that I recall from doing the short sale is that the secured bank was always concerned with the sellers, the seller slash owner debtors financial situation and wanting bank statements and wanting to know essentially what their assets are. Whereas with the receivership, all that’s irrelevant and once it goes into a receivership, all we look at is what the fair market value for the property is.

Dave:

So we do have to take a quick break, but stick around because we’ll be right back.

James:

Welcome back to the show.

Dave:

So why would a creditor choose a short sale instead of a receivership? Is it more expensive to do a receivership or is it just they don’t know that this is an option?

Jake:

I think a lot of ’em might not know that it’s an option. I’ve seen a lot of weird loans where they’re even with big traditional servicers that have just been in default with no action on behalf of the creditor for years, and I can’t really make heads or tails of why they would want the loan on their books, but I’ve just seen a lot of inactivity from some creditors. If I were in the position of a creditor and there were subordinate debts on the property, I’d be all for getting the receivership rather than short sale because you don’t have to negotiate with the subordinate liens, you don’t have to negotiate with those. Whereas with a short sale, you’d have to get everybody on board to accept it and release their debt. But with the receivership, once you get the court order saying the property’s being sold free and clear for a specific price, it’s a done deal and then the debts are paid in order of priority. So first in time, first in right, and you don’t have to worry about the mechanic and material men’s liens that might be a second or a third position.

James:

What does a typical transaction look like that comes across? You guys are hired, what does that process look like? Timelines, how is the debt cleared? What do those loans look like as they’re clearing off? Can you walk our audience through how that looks and then how that sale is finalized with the court order?

Jake:

So the process gets started by somebody filing a petition to appoint the receiver. And so it could be a creditor that files an involuntary petition. It could be the debtor that files what’s called an assignment for the benefit of creditors, and you get a general receiver appointed that has the power of sale. So once the receiver is appointed, we compile a schedule of assets and liabilities so that we can assess what we’re working with, whether it’s a single piece of real estate or multiple and who all the creditors are both secured and unsecured. So once we have that data, then we send out notice to all the creditors that are identified and we start evaluating the properties. We get them listed for sale, say we get an offer that comes in, we analyze that offer, can negotiate and do counter offers to try and make sure that we get market value for the property.

Jake:

Once an acceptable market value offer is obtained, then we file a motion with the court to approve the sale at that price on those terms, and we send notice of the motion and the contract out to all the creditors and all the equity owners and pursuant to the statute, that’s a 30 day process, somebody is entitled to 30 days notice before receivership property is sold. Then on the MLS, the listing gets changed from active to pending backup offers requested and the bidding process remains open until the judge is the one that slams the gavel down and says sold essentially.

James:

And on that bidding process to again walk the investors through, because right now it’s hard to find a deal or just trying to find inventory and a lot of times finding a deal you can pay full market value for it and it’s more about the condition of the property and you’re improving it with your plan rather than getting it on a great, great price. What is that process like? Because receivership fees can change. As an investor, we’re always kind of concerned what’s our all in number on this property? And you’ll see it listed on the MLS will be, you can write it up and sometimes there’s a 10% fee that gets added on or a 20% fee or there’s the beneficiary fees are added on top of the price. Can you touch a little bit of why those fees vary a little bit when you see it? You have to look at each deal differently and then where do those fees go and how does that affect that bottom line, whether the investor’s deal is going to go through or not, because sometimes the deal can be make or break on that fee. If it’s an extra 10%, it might not quite work. And for investors, we’re just trying to get through that motion. Can you kind of explore those fees a little bit? I know a lot of people run into those as they’re looking at buying these.

Jake:

So with our company resource Transition consultants, our fees are set pursuant to the court order, similar to real estate commissions as they were a couple of years ago, our fees are paid out of the purchase price. So it’d be really easy for you to calculate what your all-in number is when you’re looking at the property, it’s going to be whatever you’re offering to pay for the property. There wouldn’t be a hidden fee that’s tacked on.

James:

Why is there such a variance in the fees sometimes because also as investors, we’re trying to finance these deals a lot of times with hard money and hard money lenders, they want their 20% down and then sometimes they won’t even include those fees in, and so you have to come up with an extra cash to kind of buy that deal. Can receivers kind of charge it in any type of structured way or is it, I know I’ve been familiar with your guys’ process, it’s all included in the price, but what’s the big delta on how they charge those fees?

Jake:

The receivership process? It is now. It’s a creature of statute. Long, long time ago, it was a creature of common law within the legal field. There’s just like you guys I’m sure experienced in the real estate market, there’s just kind of an open entrepreneurial spirit and variation from professional to professional. And so I guess that’s the best answer I could give is somebody’s fee structure might change just because they think that they can make more money that way or either make more money on a transaction or it makes the services that they’re providing more appealable. So it is just a marketing and a personal preference.

Dave:

Jake, I’d love to switch gears and just talk about what’s happening in the receivership market today. How would you describe the state of the industry?

Jake:

It’s changing. I’d say it’s ramping up. A few years back there were a lot of owner occupants that were getting behind with their traditional mortgages, and so they’d file an assignment for the benefit of creditors as an alternative to doing a bankruptcy or trying the long and tedious short sale process that we’ve discussed. But lately what I’ve seen a lot more of are investors, so it’d be an individual that has multiple properties, whether it’s a builder or a flipper that just acquires multiple properties that they’re unable to complete or unload at their previous target price. They’d file a receivership and we get those properties liquidated for their creditors.

Dave:

And that’s where James jumps in

James:

Those greedy performance. I mean, I think the market was doing so well and rates were so low that even the lenders, we saw hard money lenders and private lenders getting very aggressive with leverage based on pretty packed performance on rent increases, on value increases. And then once those rates shot up, everything kind of hit the brakes for a minute. And because the debt, when we’re talking about more investment property, if it’s a residential homeowner, a lot of them have debt that’s three and a half percent right now. And that kind of adds up over time. But when these investors are borrowing money at 10, 12% and it’s not being paid and it’s compounding on itself, especially when it’s midstream on a project, if the house is half stabilized, the value has gone down, not gone up many times. And then the debt that was financed at a very aggressive rate where lenders were maybe financing 90% on these projects are really exposed because the value’s gone up, the debt cost has gone up or the leverage the LTV is a lot lower and then it’s just compounding on itself.

James:

And then that’s where really the opportunity is. As far as investors go too, because in today’s market, one thing we have seen is the market is rebounded fairly well, but things that need work are still not selling at the pricing it was selling for. And I know for us for investors, we’ve been targeting more half built projects where investors are kind of trying to get out than rather than even targeting the homeowner that wants to sell because there’s a lot more inventory for us to look for. And in addition to working with those lenders and the debtors, they kind of know what they’ve lent on and they want to get a deal done. When you’re negotiating with some of these lenders, because they’re more short-term commercial debt, are they working a lot more to kind of discount the notes because they just want to get paid back in full. A lot of times they’re paying investors at a higher rate too, so the more that compounds the riskier position they’re in, are you seeing lenders just trying to move stuff forward and taking bigger shorts just to get it off their books?

Jake:

Yeah, I’d say so. And I’d say that there’s a lot of willingness to smudge the default interest recouping the principle is of an utmost concern. And when we’re dealing with debts that can accumulate default interest at 24%, there’s quite a bit of motivation I’ve seen on behalf of the lenders to just get a deal done because they’ve got the same understanding that I think we all do here, that there is a point of no return where you’re not going to recoup your principal plus all the accrued interest and they just need to get the property sold, get the cash back into their account so that they can disperse it to their investors.

Dave:

So James, I’m actually curious, does that mean that when you work with the receiver, is it less competitive than a lot of the other deals that you’re looking to buy?

James:

I would say it’s not less competitive getting listed on the open market. I would say many investors they want to buy on the now and they don’t want to wait for that process even though it’s not that long half the time and they might just go past the deal. Where I do see it’s beneficial is right now we’re in a market that’s kind of gradually rebounding and when you’re getting in contract, it can take 90 days to close this, 120 days to close it. And as the market conditions improve, the deal can actually get a little bit better When you’re done stabilizing and you don’t see a lot of competition, but what you do have to watch out for those nasty bump clauses where you get a deal, you think you’re locked in, you’re going to close, and then all of a sudden there’s a bump where another buyer can bump you out a position on your deal and you either have to come back and match their offer or resubmit at that point. Or even how there’s been many of times where we’ve been on a deal, it’s going to get to court approval and another buyer shows up out of nowhere with an offer at the hearing. Can you explain that to the listeners a little bit? How does that work? What happens when you get kicked off your deal and how do you keep it under control if it starts, you get those nasty bumps?

Jake:

Yeah. Well, those late notice bumps are frustrating to everybody involved because we have to keep the court apprised of what’s going on and we have a duty to try and get the highest and best offer available, get the highest and best price for the benefit of the creditors and any equity holders. That being said, it’s a public sale process and everybody’s aware when we’re doing a transaction, we have ’em sign a specific addendum that identifies that their offer is contingent upon court approval and it’s subject to overbid. It’s up until the court approves a final sale.

Dave:

That’s super interesting. That would really bum me out if you thought you had something locked up and then that’s not how it works at the regular market. That would be very surprising.

James:

We used to have bump day in our office where we would go through every different bankruptcy. You can see it says backup requested who the broker, it’s a similar comment who the seller is. And every 30 days we would underwrite every pending bankruptcy and just trying to bump people out, especially if you knew who was on the deal. It was like a game for us.

Dave:

So you’re framing this James, if you’re like, oh, those nasty bumps, but you were the one bumping people.

James:

You know what? You got to stay on top of the market and if there’s something pending that’s right outside the box, recomp it, recomp it, recomp it. I mean there was a deal pretty recently. We had our digital offer and then the market started rebounding and we ended up getting in a bumping war and we went to our highest, it was like a hundred grand higher. And it definitely can turn into, once you get in that bidding mindset, it kind of goes like you’re going to the auction because when you go to the auction with those cashier’s checks, you want to buy that property. You get all caught up in the moment and it can definitely happen where the juices start getting turned up. But yeah, you got to watch out for the bump clauses.

Dave:

We have one more break, but stay tuned on the market. We’ll be right back.

James:

Welcome back to On the Market Podcast.

Dave:

As an analyst of the housing market, one of the defining features of the last few years has been low foreclosures. A lot of people were expecting either due to covid or inflation, all these other sort of things that are going on that foreclosures might start rising and while they have come up from pandemic levels, they’re still historically low. Is one possible explanation for that, the fact that things are going to receivership instead of going to foreclosure?

Jake:

Yeah, I think so. I think that’s a likely contributing factor. Receiverships have become a lot more common lately within the past five years or so, and as they become more and more common, bankruptcy filings actually have been trending downward because it is an alternative to a bankruptcy.

Dave:

Jake, do you have any further advice to any investors considering working with receivers on how they can get into this type of transaction?

Jake:

Well, I would say with most things, talk to a trusted professional, seek out a broker that you’re familiar with either personally or by reputation that knows about receiverships and has been through the process because there is a learning curve. I’d say just like with most things, if somebody wants to invest in property, you can’t just read a blog post and then go out and do it on your own, find somebody who’s done it to teach you how to do it.

James:

On the other side of that, Jake, there has been investors that have gotten themselves into trouble. They took on a lot of expensive debt, they got a little bit over their head and the investment at the end of the day is just going bad because the market conditions changed. They could be great people, they could add great operations, but maybe their perform was a little too packed and it just kind of changed. How is it beneficial to an investor to work with the receiver to kind of get themselves out of that mess, right? Because a lot of those loans are personally guaranteed they’re full recourse loans and they don’t want that debt to follow them. What’s the benefit for them going through the receivership? And then can you also touch on what that does to their credit and how that is going to affect them down the road?

Jake:

Primary benefits of getting the receivership started is once a receiver is appointed, the court imposes a stay similar to a bankruptcy stay to where it stops all collection activities. And so it gives a bit of a pause so that everybody can assess the situation and start a dialogue on the best way to resolve the situation, whether it’s given the collateral to the creditor or getting it sold and that add an agreed upon price. But that kind of pause and breathing room, it gives the opportunity to analyze the situation and plan a little bit more. It could affect their credit depending on whether or not the creditor reports them, if they report the loan as a default. But the interesting thing about it is that the process varies from state to state. Every state has different receivership laws and because it’s different, instead of a uniform system like a bankruptcy credit reporting agencies, they don’t have a uniform way to deal with it. So I’d say by and large, it doesn’t really impact credit scores because there’s no uniform way to report it and get it out to the credit reporting agencies.

James:

So essentially an investor, if they get in over their head needs to hire you so they can get themselves out of the mass and they get to kind of get a new fresh lease on life and go do deals in another market or another type of deal.

Jake:

Yeah, and I’d agree with the sentiment and the conclusion, but with caveat or correction that they wouldn’t be hiring me. So the receiver is an agent of the court and not a fiduciary or representative of either the creditor or the debtor.

James:

Got it.

Dave:

Alright, great. Well, Jake, thank you so much for joining us and sharing what is, I think probably a new part of the real estate investing world for most of our audience, at least it was for me. I really enjoyed learning about it and thanks so much for your time.

Jake:

Alright, thanks a lot Dave. Thanks a lot, James.

Dave:

Big thanks to Jake for joining us today. If you want to connect with him or learn more about his business as usual, we will put his contact information in the show notes below. James, hopefully you learned a couple tricks and tips for your own work with receivers today.

James:

You know what, I’m always looking for more tips and tricks to get more deals done, but as long as those nasty bump clauses don’t come at me, everything will be fine.

Dave:

Alright, great. Well, thanks for suggesting the show topic and thank you all for listening. We’ll see you for the next episode soon of On the Market. On The Market was created by me, Dave Meyer and Kaylin Bennett. The show is produced by Kaylin Bennett, with editing by Exodus Media. Copywriting is by Calico content and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.