When you buy a debt secured by a distressed property, your ultimate goal is to acquire the property. Your path for realizing that goal is to step into the lender’s shoes, and then to acquire the property by foreclosing. After you acquire the debt, you may be able to negotiate a deed in lieu of foreclosure with the borrower, but don’t count on it — and even if it’s offered, you may not want to take that deed in lieu.
From a contract standpoint, the purchase price, the deposits, the feasibility period, the escrow and the closing will all be familiar concepts, just as if you are buying a property. The closing documents will be a bit different, as will some of the representations and warranties (assuming the selling lender is generous enough to make them), and there will be some different or additional defined terms.
At closing, you will receive the original promissory note endorsed to you as the new holder. Instead of a deed, an assignment of the deed of trust that secures the note will be recorded. You should also receive assignments of the other rights and elements comprising the lender’s collateral package. Be alert for qualifications or reservations in the closing documents that negate promises or representations made in the purchase and sale agreement.
A key difference between buying the debt and buying the property is the scope of your feasibility analysis. When you buy the debt, you have two elements of analysis — the property itself and the status of the debt.
The first element — investigating the property — is no different from the analysis you would undertake if you were buying the property outright. You will want to investigate the physical condition of the property, including testing for hazardous materials and for structural integrity. Access may be an issue, however, as the lender does not own the property. The lender may provide you with its reports from its underwriting file — but typically only if you ask. The legal aspects are also the same — existing contracts and obligations that would survive, recorded use restrictions, the scope of existing entitlements (including the logistics of changing them if you intend to redevelop) and the status of the HOA in the case of a “broken” condominium project. In preparing your economic analysis, factor in costs associated with acquiring the property through foreclosure after you acquire the debt and with regaining possession from delinquent tenants after you have foreclosed.
The second element — investigating the debt — is the core of determining whether the debt is in a posture that will enable you to foreclose smoothly and quickly. The scope of analysis depends on the status of the loan, including whether the borrower has merely missed payments, whether a notice of default has been served, whether a notice of sale has been served and whether there have been any extensions or concessions granted to the borrower. Terms of loan modifications or details buried in correspondence in the lender’s loan file can make all the difference between smooth sailing or the borrower having a foothold to stop or delay the foreclosure process. Title review is also critical — other liens or interests could disrupt or derail your foreclosure.
Buying the debt presents wrinkles and risks you don’t encounter when you buy the property directly. But beneath the wrinkles and risks — there lie the opportunities.