Wrote a 24 month balloon assuming rates would fall, and I own the houses again

The document gaps are the part I'd focus on, because two of them were free. A twice-yearly inspection right with a cure period costs nothing to draft and would have shown you the sewer at month 12 instead of month 30. Annual proof of paid taxes and a certificate of insurance naming you, same. And a maintenance covenant with a specific standard, not "maintain in good repair," which means nothing when you're arguing about it.

The one I'd add that people skip is a reporting requirement. Rent roll and a P&L to you every six months. A buyer with a five month vacancy will not volunteer it, and vacancy is the earliest signal you get that the note is in trouble. You found out from a neighbor.

Uncomfortable thing to say but I'm building a list right now and if someone offered me two houses at 10% down interest only, I'd take it and I'd know exactly what I had. Cheap option on two houses for 46,500. Whatever the properties did, my downside was capped and my upside wasn't. The structure told him how to behave.

The interest only is what turned this into a full loss instead of a partial one. Three years of payments, 2,528 rising to about 2,790, so call it roughly 95k of interest collected, and zero principal. You took the properties back against the same 418,500 you started with, minus deterioration you paid 22k of and counting. If it had amortized you'd at least be arguing about a smaller number.

The line that stands out is that you underwrote a rate forecast as collateral. I've watched the same assumption in two syndication decks from that period, both with 24 to 36 month bridge exits priced off consensus rate cuts. Nobody was pricing the case where the exit financing simply doesn't exist at any value the appraiser will sign.

I'd push back on @ledger a little. Amortizing wouldn't have saved much here. 418,500 at 7.25% on 30 year amortization is about 2,855 a month, and after 33 payments the balance is roughly 405k. That's 13,500 of principal against a 31k deterioration hole. The amortization argument is right in principle and small in magnitude over three years.

The two things that would have changed the outcome are the down payment and the reserve. At 20% down he's got 93k in the deal and the sewer line is his problem because walking costs him more than fixing it. And a held capex reserve of, say, 250 a month per unit funded at closing plus monthly would have had the sewer money sitting in your account when it failed. @thicket already listed both, I just don't want the takeaway to be that amortization was the fix.

The deed in lieu timing is the other thing worth sitting with. You knew at month 22 he couldn't refinance. The extension bought you 2,500 and twelve more months of him not spending on the properties, which cost far more than the fee earned.