Ethics in Real Estate Investing
|I read something in an association newsletter a few months back that sort of shocked me. It was an article reprinted from author John T. Reed’s Website which reads in part, "They [the nothing-down gurus] claim to love seller financing because sellers are 'flexible'. But in that context, 'flexible' is just a euphemism for stupid. The seller-financing aspect of nothing down is generally unethical ...because it takes unconscionable advantage of an unsophisticated person." Reed wraps up with the interesting statement that "...the nothing-down movement consists mainly of a bunch of slime balls running around trying to find unsophisticated homeowners, typically little old ladies, and bamboozling them into trading valuable real estate equity for a near worthless piece of paper."|
What surprised me about this article was not that Reed wrote it, but that it was published without comment. I thought, “Is the reputation of real estate investors is so pathetically tarnished that we've just started accepting that we're slime balls?”. Which got me thinking about a code of ethics for real estate investors, which scared me, because it sounds like the first step toward a slippery slope of regulation, licensing, and government intervention that none of us want. So the answer has to be deciding on a code of ethics for our businesses, and then sticking to it even when it costs us money.
The Definition of "Ethics"
Webster's defines Ethics as "1) a system of moral principals. 2) the rules of conduct governing a particular group, culture, etc..." Most people think of ethics as relating to fairness, which is only a partial understanding and leads to the kind of thinking that Mr. Reed has engaged in. The basic fallacy of his argument is that it assumes that the world is a fair place in which everyone has time and options.
People in the investing business know that nothing-down deals are done not when sellers don't understand their options, but when they understand them all too well. I am dealing this week with two sellers who will lose their houses within the month unless they find someone to take make their payments; neither has 90 days to look for a buyer, and even if they did, it's unlikely they’d find one who could pay cash for these junkers. Did I create the events in these seller's lives that led them to this situation? No. Is it "fair" that bad things happen to people? No. Is it unethical of me to use my expertise to make money solving their problem, when their other "choice" is foreclosure? You decide.
Although I disagree with Mr. Reed’s assessment that nothing-down deals are unethical, there are a number of things that investors do–unthinkingly, rather than maliciously, I hope–that do fit the definition of unethical. Here are a few.
Lying to Lenders
In recent years, it has become common for mortgage brokers to make risky loans happen by getting appraisals that reflect a value higher than the true market value of the property. Out-of-town lenders accept these appraisals at face value, and make loans at 80% or so of the appraised value to borrowers with marginal credit. As a result, many lenders have been unknowingly making loans on properties with no equity to homeowners who don’t have the credit to support such a mortgage. We’ve all seen the results of this in the huge increase in the number of foreclosures in the last 12 months, not to mention the number of sellers we can’t help because they’re over-leveraged on loans with sky-high interest rates. In these deals, the lender loses and the borrower loses. The only “winners” are the mortgage brokers who were paid to put the deals together and the sellers who sold their properties for top price plus–many of whom, unfortunately, were investors.
Thanks to the problems this has caused, a new laws are being passed to “control” the parties involved. Throughout the country, newspapers are writing “expose” stories on poor homeowners who’ve lost their homes thanks to unscrupulous brokers and investors. Lenders have tightened their standards, and honest appraisers are so afraid of being accused of fraud that they’re hesitant to appraise a property for more than its most recent purchase price. The result? Those of us who are doing legitimate repair and resell deals are having a difficult time getting loans for our buyers. Investors who have engaged in or cooperated with this scam have cost lenders hundreds of millions of dollars, cost thousands of buyers the American dream and cost the industry it’s reputation. So when my fellow investors tell me that they aren’t doing anything “wrong” by helping make these deals happen, I just have to wonder.
One of the most heinous–and common–things I’ve witnessed is the "wholesaling" of properties based on false figures. Apparently, these folks have forgotten what wholesaling is. Wholesalers are supposed to leave a lot of profit in a deal for the buyer, not sell properties at a price where the buyer can’t make any money! I know too many wholesalers who prey on inexperienced investors by "proving" (through fake appraisals or by using those high-end comps created by those deals I outlined above) that the property is worth more than it actually is. In fact, some wholesalers I know won’t work with experienced investors anymore, because they've discovered that they can charge newbies thousands of dollars more for the same properties! When you can convince someone who's new in the business that you're a good guy and an expert, it’s not hard to convince them to overpay. But when you prey on the trust of people who don’t know any better to sell them deals that can’t be profitable, you're scum who doesn't deserve the name wholesaler. The buyer should not have to beware of you.
Ethics in Landlording
Every month or so, I receive a call from a concerned citizen asking what he can do about a neighborhood landlord. These questions generally fall into one of two categories:
1) How can I get a landlord to control/evict/ talk to his horrible tenant, and
2) How can I get a landlord to repair/maintain his horrible property.
A few years ago, I would have responded to these callers by saying that a bad tenant isn't a landlord's responsibility, that problems between neighbors are part of life, and that it was horribly unfair that landlords are held to a different standard than homeowners in terms of the condition of their properties. Years of hearing horror stories (I can't sell my home because the renters next door keep throwing bottles and yelling obscenities at the potential buyers; landlord tells me to !?#@ myself when I complain to him) and seeing the havoc that one rundown rental property with nightmare tenants can wreak on a neighborhood, I have changed my tune about a landlord's ethical responsibilities.
Like it or not, landlords do have an obligation to the neighborhoods in which they purchase properties. Just as you wouldn't want a noisy, destructive, violent, drug-dealing neighbor to move in next to your family, you shouldn't inflict such a tenant on somebody else's neighborhood. And yet, landlords rarely take tenant screening seriously–or look only at an applicant’s ability to pay the deposit and the monthly rent, ignoring that he is a terrible person to live next door to.
Beyond this, I think there's another obligation to keep properties maintained at least to the level of the rest of the neighborhood. Now, let me emphasize that I am a BIG fan of private property rights, and don't believe that the government (or anyone else, for that matter) has the right to enter into, tell me what to do with, or otherwise control my property. I think that most "building codes" are meant to raise money for the city, not to protect the health, welfare, or property values of the citizenry. Nonetheless, whether the legal obligation is there or not, I think that there is an ethical obligation on the part of landlords (and all other property owners, for that matter) to avoid interfering with the property values of their neighbors by owning eyesores.
I honestly don't believe that the majority of "slumlords" set out to be that way. In fact, I think that the problem is that too many rental property owners get into the business without the proper education, skills, or connections to solve problems as they arise, and that too many are "undercapitalized"—they don't put aside enough money to cover inevitable repairs to their properties. I suspect that unpreparedness and lack of ready cash cause 99% of the friction between landlords and neighborhoods. But whether the owners of trouble properties set out to be the bad guys or not, they hurt the neighborhoods where they invest, and ultimately hurt the rest of us by causing our cities and states to pass inspection, licensing, and occupancy laws to "control" landlords.
The message comes down to this: housing providers have enough of an image problem to overcome without adding to it by taking advantage of people. There's enough money to be made in this business when you're taking care to do right by everyone you deal with. If you're cheating or lying to your customers, or if neighborhoods cringe when you buy properties there, something's not right. Please, reevaluate your business before the government does it for you.
|Vena Jones-Cox is a past president of the Real Estate Investor’s Association of Cincinnati, the Ohio Real Estate Investor’s Association, and the National Real Estate Investor’s Association. Vena has been featured in publications such as The Cincinnati Enquirer, Smart Money Magazine, Money Magazine and Reader’s Digest in articles about successful real estate entrepreneurs.|
Vena Jones-Cox’s real estate business focuses on finding great deals on 1-3 family homes, and then lease/optioning them to homeowners or wholesaling them to investors and renovators. All told, she buys and sells about 50 properties per year.
Vena is a frequent guest lecturer at real estate investment groups throughout the country, and particularly enjoys working with new investors. Vena frequently authors articles on real estate investment and the regulatory environment for various newsletters and publications, including her own monthly newsletter. She has been a guest speaker at the Cato Institute in Washington, D.C., lecturing on the effects of lead-based paint regulation on small investors. And in her spare time, Vena Jones-Cox hosts a popular weekly call-in radio program on public radio.
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