In today’s world people are looking to make high profits with low risk. One of the favorite ways to do so is with income property, and in particular, investments in land already zoned for a commercial purpose on which sits a fast food restaurant. The players in this real estate human tragedy are: (1) a 75-year old buyer (who we will call Manuel) who suffered serious losses in the 2007 – 2008 downturn, (2) the seller, a highly-experienced franchisee and real estate owner, (3) a California broker and an out-of-state real estate broker, and (4) an out of state building contractor who was contracted to construct the fast food restaurant.
The California broker was a longtime friend of Manuel and also very experienced, successful and good at his trade. He suggested a NNN commercial investment. This would involve buying commercial land approved for a nationally-known fast food restaurant, then leasing the land to a fast food franchisee to collect rent, obtain tax benefits and land appreciation. The way it was presented (by means of a brochure) it seemed as though the land owner could not lose: he owns the land and the improvement, receives rent from the franchisee tenant, and is then able to see the value of this investment soar.
This brochure further stated that the seller was going to be the franchise operator/tenant, there would be a CAP rate of 7%, the rent was projected out for several years, and construction of the restaurant was to be completed by August 2011.
Manuel asked his California broker friend to represent him in this deal, who agreed, travelling out of state with him to see the property, meet the seller and conduct due diligence. Manuel signed the deal to buy the property on June 26, 2011, but saw no restaurant because none had been built. The closing date was initially to be August 28, 2011.
While the brochure promised much, ultimately its glossy promise only yielded a messy lawsuit.
For starters, the seller did not own the property when he signed the purchase contract with Manuel. Instead, he purchased the property for about $350,000 on August 28, 2011 (the original closing date), and then turned around and sold the land and improvement to Manuel for $1,850,000 (which now included the restaurant). The deal then closed two days later on August 30, 2011. At purchase, the seller signed a NNN lease, personally guaranteeing that the rent of $15,000.00 would be paid each month for 20 years with two, 10-year options to extend.
From November 27, 2011 to March 10, 2012, the contractor was building the restaurant. Unfortunately, the seller stopped paying the contractor leaving $500,000+ owed. The contractor then filed a mechanics lien against the property in June 2012. No one paid the amount of the lien so the contractor sued on this lien. Although Manuel was named as a defendant, he never answered the lien complaint so the contractor took his default and scheduled a foreclosure sale at which point, Manuel had no choice but to pay the lien which was now up to $715,000; otherwise, he would have lost everything.
Manuel was mightily pissed off. In point of fact, though, Manuel caused most of his own mess because (1), he had notice of the lawsuit by the contractor but did nothing; (2), he bought the property and signed the NNN lease before anything was built; (3), he was getting $15,000 a month in rent so he didn’t care if there was a restaurant or not and ignored what he knew was a real lawsuit against him.
Instead, Manuel’s response was to sue everyone involved in the Los Angeles Superior Court. The result was that the brokers pointed fingers at the seller and Manuel; everyone argued that they did nothing wrong; questions arose over which defendant had any money to pay; lawyers’ fees skyrocketed; and Manuel played dumb and stopped speaking to his California broker.
As is often the case when an “innocent” (even a phony one such as Manuel) cries negligence, fraud, breach of fiduciary duty, etc., the tune carries very long and loud. This case went on for a couple years during which time Manuel and his broker’s friendship crashed and burned. The seller/franchisee cross complained against Manuel, both brokers pleaded no liability, and, ultimately, the case settled. Manuel got a pittance from everyone except the seller, who presumably repaid the $715,000 — or close to it – to Manuel.
The moral of this sad NNN investment tale is simple: You cannot trust anyone. If you sign a real estate purchase contract, verify that the seller owns the land. If a building is supposed to be there, make sure it is there or could be built by the date you expect it to be done. That means you must visit the site and look with your own eyes. Create documentation that states that if the seller doesn’t pay the contractor, you (the buyer) are protected. Pay for the best title reports possible and NEVER BELIEVE ANY BROCHURE!
Manuel feigned ignorance of real estate investments but he had previously owned apartment buildings and was very savvy. Then, he ignored the notice of lien sale by the contractor and never paid a lawyer to answer the lien lawsuit out of state. Instead, he blamed the brokers, the seller and everyone else he could find while pumping up his damages because he collected the agreed upon rent throughout the time period involved. Sure, he was out some money, but it was far less than what he was claiming or what he was trying to get from all the other players.
If one is a broker or other party to a real estate deal that goes bad, expect a lawsuit. All personal loyalties evaporate because as a licensed professional, a broker has to justify every word, deed, dollar and promise, and must do so in writing. Brokers are held to high standards to protect their clients.
If you have a client who is focusing on your errors and omissions policy because a deal went bad, or your client sets up such a scenario, be sure all disclosures are in writing and are in place. Make sure that an approved real estate contract is being used, that you are licensed where you are signing the deal and where the property is located. Or, if you don’t have the ability to do that, partner with an out of state licensed broker.
And if all else fails, JUST PRAY!