I've been humming that old Billy Joel song, "Honesty," for the last couple of days, so I suppose I should be posting a thing or two about it in relation to our experience in the commercial real estate industry. That's better than making my family listen to me sing it for a few more days. Let me first state my little disclaimer: I have no doubt that there are plenty of honest people in the commercial RE sector, but we have never had the good fortune to meet one of them.
We may have lost a ton of money, but we retained what money can't buy--integrity (let's not forget our sanity, too). Would it have been easier, faster, and more profitable to fudge a few numbers and tell a couple of white lies in order to unload our properties--just enough where it wouldn't be worth someone's money to sue us? Heck, yeah!! But then how could I have lived with myself knowing that I did the same thing to someone else that caused us so much heartache? Frankly, I wasn't even tempted. I wish that I could say that about others involved in this wacky business. Do you remember the cartoons when one of the characters realized he'd been duped? He would turn into a lollipop--SUCKER! Well, I believe that's what people in this field saw when we came their way.
Initially, it all seemed so innocent--"Let's project the utility expense just a bit lower here to qualify you for the loan." My mortgage broker seemed like a nice family man, and I enjoyed working with him. He wasn't a scumbag, that's for sure. But when it came to shifting this and moving that, he knew exactly what to do. Since we were dealing with the rehab property, it made perfect sense to try to determine the numbers at full occupancy. Later on, though, we realized that these numbers made no sense based on the history of the complex. How could you lower the utility costs when you plan to add 40% more tenants? Maybe we were supposed to manage it better than the last tightwad who owned it.
The owners of the buildings that we considered buying had no qualms about misrepresenting everything: deferred maintenance, age of the roof, number of tenants, amount of rents, number of paying tenants, cost of utilities, amount of property taxes, pretty much anything we asked. It was so bad that I would call the county office to find out what the property taxes were currently and what they would be once we purchased the complex. The number of lies were ridiculous. Then we would request a package and the disclosures didn't look anything like the claims--or they contained inconsistencies that would tell us that something wasn't right. My husband set up a program on excel (or something like it) and would plug everything into his computer. We disqualified more properties than I can remember.
I guess that didn't do us a whole lot of good because the Ohio property fooled us. Initially, we dismissed it, but then I received an e-mail from the agent saying that the contract on it fell through and it was being reduced. I asked him why the buyers pulled out and he said that they couldn't come up with the down payment. Now, I think he was not being honest. I also believe that this OH seller completely forged many of the disclosure documents, including the 12 month history and two years of tax records, in addition to the copies of the leases.
I believe this because, as we were firing his managers due to their inability to collect the rent (they must have thought that a philanthropic organization bought the place), the woman told me that the prior owner only required them to collect enough to pay the mortgage, which was $20,000 (including tax and insurance impounds). His documents showed that he collected between $28,000 and $32,000 per month for the immediate 12 months prior. Then I had to call the insurance agent who we both used because they didn't send the bill to the mortgage company. The agent told me that the prior owner had desired to continue to carry liability insurance on the building after it was sold to us. He said the seller told him that he was afraid of being sued. Let's analyze that for a moment. He couldn't be sued by a tenant because he was no longer liable, unless there was a lingering issue, which he would have been required to disclose to us. However, we had owned it for 18 months by then and knew of no tenant who had a beef with him (of course not, he didn't make them pay the rent!). By the process of elimination, who else would sue him over the building---that would be us, the idiot buyers. The agent was not able to provide him for coverage on something that he no longer owned.
We also found that, although the seller and his manager claimed that the building was 100% occupied, our new PM found many vacancies--to the tune of 12. We could have foreseen this if we had required Estoppel certificates from all of the tenants (although, I have to say that those can be easily forged, too). The best way to determine the performance of a prospective property is to hire a new PM and have them walk the property, inspect the units, and review the leases (they looked good to us, but, again, easy to forge). I would never keep the management company of a prior owner unless they were closely scrutinized, their other buildings were inspected, and other PM's in the area were interviewed. I did not want to keep these managers, but the seller and agent insisted that we would make more money if we did. It must have been opposite day!
I have to say, though, that commercial real estate agents take the cake in dishonesty. Most seem to learn as little as possible about the property so that they can misrepresent it without feeling guilty, I guess. The agent who we used to sell our OH property made things up on the spot, like the fact that we were doing a 1031 exchange (wrong) or the reason for selling it (had no idea) or the numbers that we gave him (they were projected for the rest of the year, but he represented them as actual). Every time I corrected him, he would claim that he didn't know. I found it common to ask agents about a property and they would have to get back to me after asking the owner. I guess this makes their answers seem more legit on their part.
The worst agent, who we had the pleasure to do business with, was our KY guy. He co-owns one of the biggest commercial real estate firms in the city, and quite possibly the state. It was really unbelievable how low he would stoop to have things work to his advantage. (If you are interested in buying in KY and would like his name, so that you can avoid him at all costs, just send me an e-mail on the link). Every person with whom we came in contact after we retained him knew of his reputation to be less than forthcoming, to say the least.
He is a part of something called Real Source (as were our scary PM's there--are you surprised to learn that they knew each other?). He almost blatantly refused to sell to anyone outside of Real Source. Most of those he met through it were new investors. So, in February, he was successful in getting us a contract on the property for $1,490,000 (we sold it for $1,075,000 this month). It was with new investors from northern California.
My husband flew out for the inspection. He saw our agent, who was also the buyers' agent, collude with the inspector to hide small defects that he found. The inspector also claimed that the ancient boiler would last another 50 years. We didn't have any information that it didn't, but I would be very doubtful. We received a report that had no requests for repairs. This was a 70's building still undergoing rehab. What?! As we considered our options on how to proceed, I was relieved that our brainless PM sent them a rent roll showing that a few of the tenants owed us back rent, and the buyers got nervous and pulled out. Whew!
After that, our agent disappeared. We had no activity and were locked in with him until September. I contacted someone I knew professionally from the local apartment association to tell her how horrid our managers were and that we needed new ones. She thought of an interested buyer and had her agent daughter work directly with me to negotiate a deal. I tried to cut my agent loose, but he wouldn't release me from his contract. So he agreed to take $7,500 in commissions and didn't lift a finger during the close. Then, a week after it closed, he called my husband to ask if he'd be interested in buying a Real Source property. My husband was kind enough not to hang up on him--maybe that's why he didn't call me.
I had planned to get into the lies that the property managers told, but, frankly, this is getting too long and depressing. It's a good lesson to learn though, especially if you are new to commercial RE. Don't take anything that anyone tells you at face value--especially if they have an innocent sounding southern drawl. Check and double check everything. We had an attorney, but we probably should have included him more in the property search process (we tried to avoid the $175/hour fee as much as possible--see where that got us?). We knew that the proformas on LoopNet were just made up numbers, so we should have been more alert for other areas of fraud.
Hopefully, you are able to learn from our mistakes and not be too afraid to dip your toes in commercial RE. I've always been intrigued by NNN retail properties. If anyone has experience with owning these, please share.