Understanding Liens—a Gold Mine or Land Mine, Part 1

Warren Buffet is widely regarded as one of the greatest investors of all time. Though he’s not famous for real estate investing, his principles are universal. Buffet built his fortune on value investing and the idea that you make your money when you buy, not when you sell. He has long talked about buying shares of undervalued and distressed businesses, which Buffet refers to as the “cigar butts” on the sidewalk.

For real estate investors, the “cigar butt” properties are frequently those with liens attached. Though liens often scare off investors, this article will discuss how investors can benefit from a careful and purposeful strategy of seeking out lien-infected properties as value opportunities.

The first rule investors should embrace is to know what you’re buying. It’s ok to buy that hot dog spinning around at the 7-11 since the Bush administration, but only if that’s the value purchase you intend to make and you know what you’re getting. What you want to avoid is believing you’re buying a filet mignon only to receive that hot dog.

A “lien” is defined as “a legal claim on real property granting the holder of the lien a specific amount of money upon the sale of that property.” Every mortgage is a lien and there are many other types. These include, but are not limited to, liens involving community associations, construction, money judgments against the property owner, taxes and municipal/code enforcement debts.

There are benefits to buying properties with liens attached. The owner is likely to be more motivated to sell to get out from under the burden of the liens. The buyer may benefit from that situation by having greater leverage during deal negotiations. Commonly, sellers burdened by liens need cash. There is often a lot of stress on the property owner who wants out. Liens on a property usually come with personal liability for its owner on that underlying debt.

For example, a mortgage is a document that secures payment of a promissory note with collateral (the property). That promissory note debt is a personal liability to the borrower. If a lender forecloses on the mortgage for failure to pay the note, the borrower (who is typically also the property owner) is personally liable for any deficiency between the value of the property to which the lender takes title and the final debt owed. For the ethical investor seeking “win-win” deals, there is a great opportunity to help a distressed seller while helping oneself.

In honoring the key concept of knowing what you’re buying, due diligence is crucial for an investor. When considering a purchase opportunity, a good way to start is by ordering a title search known as an “ownership and encumbrance,” or “pencil” search. This is similar to a title search performed by a title insurance underwriter leading up to a closing, but without producing a commitment for a title insurance policy to be issued at closing.

A pencil search will provide a review of public records concerning a property to show liens in existence as well as judgments against the property owner and other matters that may affect the quality of title. There are service-providers who produce thorough and accurate reports for a fee of less than $50. Considering the potential costs of unwanted surprises, investors should consider a pencil search as a cost of doing business to ensure they know exactly what they may be buying.

Once the investor determines what liens attach to the property, they can calculate the approximate costs of those liens. It may be difficult to determine the exact costs unless you are able to obtain written payoff statements from the lien-holders. Getting such precise information may be a challenge. For example, a mortgage recorded in the public records will contain the face value of the original debt, but the payment history and current balance owed are not matters of public record. If the owner is very motivated and cooperative, they may help the prospective buyer get payoff statements for the liens.

Follow us to read our multiple-part series on understanding liens and how investors can use liens to determine value opportunities. If you have questions about real estate matters such as this, contact attorney Charles Castellon today.