Dirty Rotten Scoundrels

I heard a story yesterday that really pissed me off. I feel the need to share it with you. It involves a local guy who wanted to buy an investment property, a local builder who had several very high priced houses to sell but no buyers, and a bank with money to lend. The story takes place just a few years back when real estate sales in Key West were still go-go.

We now know that a lot of people bought a lot of properties in Key West at what now seems very inflated prices. Up until the mid 1970s when Key West was "discovered" by gays and hippies, prices for real estate were low. A few years back I sold a small house on Stock Island to local woman who told me of the time when her father passed up the chance to buy an entire block on upper Duval that would have cost him $70,000 (which was a lot of money at that time). She implored "Gary do you know how much that would be worth today?" I did.

As Key West became a destination for gays, lefties, and counter culture types, prices for real estate started to tick up. More people came and saw how wonderful this little island is and decided they wanted to own a place in Paradise. The more people came, the higher the prices rose. A broader spectrum of visitors started to travel here when big cruise ships made daily voyages to the city. The allure of Key West became known around the world in magazines, TV shows, and movies. A new group of buyers who were more Wall Street than Duval Street types started to eye Key West as a place to invest. And prices for houses of any type went even higher. There was not enough supply of old homes to go around. New places were built so that more buyers could buy more new places in Key West. The new properties weren't cheap; most of the new properties were trophy houses.

The local guy had saved some money which he wanted to invest in Key West real estate. The problem is his wad was only large enough to pay a pittance of the asking price of a particular new Key West trophy house. He and a lifelong acquaintance pooled their funds and came up with just about 11% of the purchase price which they planned to use as the down payment. Since the property was classified by the bank as an investment, the buying duo would need to come up with a total 25% of the purchase price - or its equivalent. The builder had not sold any of his units at this point and really felt the need to get one sale under the belt. That sale was critical to his marketing plan for his properties since it would establish the bona fides of the asking price. One high priced closed sale would be proof to the world that the trophy house development was worth the trophy asking price. The builder offered to carry back a soft note (non interest bearing with principal deferred far into the future.) The builder even "advanced" over $300,000 in real cash money to the duo which was placed in a "reserve" account at the bank where the new purchase mortgage was made. The reserve funds were to be used to pay the principal and interest payments, taxes, insurance, and operating costs of the property as long as the funds held out. The $300,000 payment from builder to buyers was treated as a gift for federal income tax purposes and the buying duo used some of the reserve fund to pay their individual taxes. The bank (the mortgage lender) was fully aware of all this. Everything.

When I heard this story I asked "Why would the builder do this?" "He had no sales" I was told. This sale was the builder's first for this development, and it was done to entice others to close on existing contracts and to entice other new buyers. It worked. I asked if the bank knew what was going on and the buyer named the bank officer who was involved in the planning.

Over the following few years real estate property values sank across the board from their inflated highs. Some of the subsequent buyers in the same development have already lost their properties through foreclosures or short sales at new sales prices less than half of what they paid. The local builder forgave the soft loan to the local duo. The reserve fund is now depleted. The local buyer and his investment pal have no funds to repay the mortgage. The bank recently offered the defaulting duo a loan modification which would include reducing the on-book mortgage to a set amount (about a 50% reduction form what is owed) but would also require the duo to sign a new soft note for the balance. I assume the bank is trying to defer taking a present write off of the difference.

Do you remember the movie DIRTY ROTTEN SCOUNDRELS? It is about a pair of con men that set out to take other peoples money. In the movie the cons con each other and get conned themselves. It seems in con games nobody is safe, nor pure. I found this short treatise on The Art of the Con - CLICK HERE. It will only take a couple of minutes to read. Substitute "real estate" for "stock". The con is the same.

In the movie Dirty Rotten Scoundrels the con men were suave and funny, and even though everybody got screwed a little, it was all just fun in the end.